The United States
Ten-year US Treasuries briefly above 3% again
Last week, 10-year US Treasury yields climbed from below 2.75% to around 2.94% on June 3. On June 6 (Monday), they climbed briefly to around 3.04%. But on June 7 they dropped back to around 3%. The US Federal Reserve has now entered its “quiet period” ahead of next week’s key interest rate announcement (June 16). This means that financial markets will not receive any more guidance from the Fed before then.
US inflation figures will be published on Friday
On Friday, June 10, markets will focus on US inflation figures – an important part of the picture ahead of next week’s monetary policy announcement from the Federal Reserve. In yesterday’s Morning Alert, SEB’s US economist and Fed watcher Elisabet Kopelman wrote that the US inflation outlook remains uncertain but that we expect May statistics to confirm the picture that inflation peaked in March, although primarily driven by base effects.
ECB monetary policy announcement
On Thursday, June 9 (tomorrow) the European Central Bank will make an announcement on key interest rates and other elements of its monetary policy. We expect the ECB to say it has decided to conclude its net asset purchases at the end of June and to clearly signal a key rate hike at its July policy meeting. The ECB will also present new macro forecasts related to euro zone inflation and economic growth.
Our market view
During the past year, the interest rate and bond yield situation has changed dramatically. Inflation began climbing in 2021. This past winter it became clear that this upturn would be bigger and last longer than most forecasters had predicted. Early in 2022 the inflation picture worsened further, with continued high worldwide demand but also continued supply side problems. Already-overextended global value chains have been further strained by widespread pandemic-related lockdowns in China. In addition, the tragic Ukraine war has driven up commodity prices and contributed to global supply disruptions.
Like most observers, we expect inflation to peak this year – very soon in the US and during the coming months in the euro zone and Sweden. But the downturn will be relatively prolonged. Inflation will exceed central bank targets at least during 2023.
There is no doubt that central banks will raise their key interest rates − some, including the US Federal Reserve, have already begun this process – and that they will end stimulative bond purchases. In some cases they will even begin selling bonds, again led by the US Federal Reserve. It remains to be seen how far central banks will hike their key rates. Their aim is to bring down inflation and cool off economies, not to trigger a deep downturn.
So the impact of the rate hikes on inflation will be crucial in determining their size. Tightening monetary policy just enough to slow down the economy without falling into recession has historically proved to be a difficult balancing act, boosting the risk of recession.
We expect the Fed to hike its key rate to 3.5% next year and Sweden’s Riksbank to raise the repo rate to 1.75%. Higher key rates and inflation have an impact on long-term bond yields, which have already skyrocketed. Reduced central bank bond purchases will also contribute to higher yields and volatility.
In our main scenario − a soft landing in the economy and central bank rate hikes helping bring down inflation towards target − we expect long-term yields to level out to about the same as short-term ones next year − around 3.5% in the US and just below 2% in Sweden. This would imply yield upturns of just over 0.5 percentage points during 2023.
All else being equal, rising bond yields are obviously not good for stock market performance, as we can see in this year's falling share prices. Equities are also being affected by the uncertainty surrounding the economy and thus the earnings potential of companies. On the other hand, due to stock market declines, both share valuations and investors’ risk appetite have of course fallen. This provides some hope, in any case if inflation falls without much further damage to economic growth and earnings.
Bond investments also took a beating early this year, with rising yields leading to price downturns. But the good news here is that yields are now starting to reach levels where fixed income investments may once again be an attractive alternative, after many years of almost non-existent yields and low potential returns.
We are still hesitant about investing in government bonds, whose rising yields may eat up much of potential returns. For corporate bonds, however, the situation is a little different. The credit spread − the extra rate companies have to pay for their borrowing − has been pulled apart by market turbulence, which means that running yields are starting to reach appetising levels.
Given economic uncertainty, new yield upturns or widening credit spreads cannot be ruled out. This would result in further price declines, but would also increase the probability that a buying opportunity will arise.