During the recent rate rally, the Canadian 10-year government bond yield held at 1.45% and has bounced slightly from there, but still remains at the lower end of its recent range.1 Economic data has tapered off from the strong rebound seen in the first quarter and the Bank of Canada continues to keep monetary policy on hold. The U.S.’s recently imposed tariffs on Canadian softwood exports raised concerns about broader trade implications. In addition, a Canadian subprime mortgage lender has experienced a liquidity drain, drawing attention to an area of the mortgage market that is not typically in the news. We would expect Canadian yields to remain supported in any sell-off.
Below is the latest outlook for global interest rates from the Invesco Fixed Income team.
Stronger global growth is likely to be supportive of higher U.S. yields and normalization of global central bank policy. Market anticipation of the end of global quantitative easing (QE) programs should drive U.S. yields higher. We expect the U.S. Federal Reserve (Fed) to hike rates two more times this year as well as announce a reduction in the reinvestment of principal payments from its securities holdings.
The risks around the French elections are now behind us and we likely do not face a far right insurgency in the next electoral test: Germany. In the background, European data continue to be solid and resilient to political risks. Given the French election’s market-friendly outcome, we expect a renewed focus on fundamentals and European Central Bank (ECB) watching going forward. As post-election short covering winds down, we would expect European core yields to resume their upward trend and peripheral spreads versus German bunds to widen again. The periphery could come under more pressure in the unlikely event that early elections are held in Italy.
The onshore Chinese government bond (CGB) yield curve bear flattened (short-term rates rose faster than long-term rates) in the first half of May. This was mainly due to selling pressure from (1) bond funds faced with rising redemptions from banks and (2) banks’ own trading and investment books. Banks were forced to reduce their fund investments after China’s bank regulator mandated reduced banking sector, and especially interbank (including non-bank financial institution), leverage. Together with tightened macro-prudential rules, we believe this move will likely slow broader credit growth in the second and third quarters, which should negatively impact economic growth momentum in the second half of this year. Therefore, we remain cautious on CGBs in the near term, but bullish in the medium term.
The Bank of Japan (BoJ) has been quietly tapering its QE purchases recently without drawing much attention to its efforts. This comes amid a weak inflation backdrop and likely continued disappointment as indicated by the Citi inflation surprise index. We would expect the central bank to continue with such an approach over the near term and to retain its 10-year JGB yield target of “around zero.” Such an approach will keep the BoJ on the same path as other major central banks (i.e. tightening policy) while providing the greatest level of flexibility to reverse course should incoming data warrant it. We believe BoJ Governor Kuroda remains very much in control.
We could well see a step up in Brexit rhetoric (from both sides) in the run-up to the U.K. general election on June 8. Now that Article 50 has been triggered, the Europeans will be seeking to set the tone for the talks that lie ahead. Some of the preliminary tactics adopted have not been well received in the U.K. A continuation of such tactics is also unlikely to be well received by the U.K. Prime Minister, Theresa May, particularly as she travels the country seeking votes over the next month. She may come across as overly harsh, in her stance, during this time. While we expect the U.K. economy to weaken as the year progresses, we believe that the market consensus is overly pessimistic. We expect gilts to underperform both U.S. Treasuries and bunds in the short-to-medium term.
The Reserve Bank of Australia (RBA) held rates steady at 1.50% at its May 2 meeting as expected.2 The statement noted upbeat global economic conditions and labor growth, but cautioned about the recent decline in commodity prices and the likelihood of low wage growth going forward. The RBA remains concerned about the housing market, stubbornly high unemployment and lower than desired inflation. With all these concerns and current conditions, the RBA is likely to remain on hold for the foreseeable future. We remain neutral on Australian interest rates.
With contributions from Rob Waldner, Chief Strategist, James Ong, Senior Macro Strategist, Noelle Corum, Macro Analyst, Sean Connery, Portfolio Manager, Scott Case, Portfolio Manager, Josef Portelli, Portfolio Manager, Ken Hu, CIO Asia Pacific,Yi Hu, Senior Credit Analyst and Alex Schwiersch, Portfolio Manager.