- Capital Economics says markets are only priced for three rate hikes by the US Fed to the middle of next year, when they should be priced for four.
- As a result, CE’s Oliver Jones said more strong data could see US 10-year bond yields reach 3.25%.
- But Jones said US 10-years will end 2019 back at 2.5%, as the effect of tighter Fed policy drags on the economy.
The US Federal Reserve will raise rates quicker than the market currently expects, Capital Economics says.
And as a result, analyst Oliver Jones expects US 10-year bond yields — the global benchmark — are “likely to rise decisively above 3% soon”.
When US 10-years edged above 3% in April this year, it marked the first time they had breached that mark since January 2014.
But apart from being a round number to use as a benchmark, the 3% rate has no real significance.
Of more importance are the various economic data points which influence the Fed’s policy outlook. And Jones says that data has been strong lately.
“We think the dip in core CPI inflation in August was a blip,” Jones said.
Rather, “the data broadly support our view that the Fed will press ahead and keep raising interest rates by 25 basis points once a quarter, between now and the middle of next year.”
The first of those is almost certain to occur later this month, and there’s currently about a 75% probability that the Fed will hike again in December.
But looking further ahead, markets are currently only priced for one more rate hike to the middle of 2019.
“Fed funds futures point to roughly three more rate hikes in that time rather than four – so we suspect that it will help to push up Treasury yields in the next few months,” Jones said.
To support his view, Jones pointed to another round of strong economic data released last week.
Retail sales missed forecasts but previous months were revised up, which means the figures are still indicative of a strong print for Q3 GDP.
In addition, industrial production data and the latest consumer sentiment survey beat expectations.
Jones added that trade war fears may have helped to keep rates lower by creating demand for safe-haven assets, but he doesn’t expect that to offset the effect of tighter Fed policy in response to strong US growth.
And as the Fed hikes rates faster than the market currently expects, he said the short end of the US yield curve will continue to steepen.
“We think that the curve, as measured by the 10-year/2-year spread, will invert at some point between now and the middle of 2019.”
An inverted yield curve is historically signicant because it’s often signals that a recession will follow, although many analysts don’t think that will happen this time.
But regardless, Jones doesn’t expect it will invert for long.
Instead, he expects the US economy to “slow sharply” in the second half of next year, as the effects of the Fed’s tightening cycle begin to bite.
And and that point, Jones raised the prospect that rate cuts would then be on the cards — another view which puts him at odds with the market.
“In contrast, investors seem be anticipating that rates will continue to rise in the second half of 2019, and not fall back significantly after that.”
The net result is that Jones expects US 10-year bond yields to reach 3.25%, before falling to 2.5% by the end of next year.
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