Raising our rate forecasts
The US vaccination drive is progressing more quickly than even the US government initially expected. This positive development, along with solid ongoing budgetary support, means the US economy could reopen sooner than had been expected, and the recovery stronger. We have raised our 2021 US growth forecast up from 5.6% to 6.5%. We expect 15% GDP growth (annualised) in the second quarter.
On the back of this revision, we are also raising our year-end US 10-year Treasury yield forecast to 2.1% (from 1.7%). We see the next leg up for yields being driven by real yields rather than breakeven inflation rates: we expect the 10-year real yield to rise to -0.1% by the end of the year. We are also raising our year-end forecast for 10-year Bund yields to 0.0% (from -0.2% previously). In the near term, the 10-year Bund yield is likely to hover around -0.3%, but the broader picture is for yields to rise once the economic recovery gains traction in late Q2 / early Q3.
We do not expect the Federal Reserve to hike short-term rates before mid-2024, nor the European Central Bank (ECB) before 2025. In the near term the ECB’s focus is on augmenting its weekly purchases of bonds as it tries to slow down the rise in Bund yields while controlling peripheral bond spreads against a precarious covid-19 backdrop on the continent. In all, we expect the short ends of yield curves on both sides of the Atlantic to remain well anchored as we still see central banks remaining very dovish: they are in no rush to tighten against a backdrop of high government and private debt inherited from the covid-19 shock. Our soft Modern Monetary Theory (MMT) thesis continues to apply.
The recent decision by the German Constitutional Court to halt the ratification of the EU’s “own-resources decision” in Germany could put our new rates forecast at risk if it leads to a significant delay in the disbursement of the Next Generation EU (the EU’s recovery instrument). Our baseline scenario is for this disbursement to occur in Q3.