Bonds: Onward and upward – BNPP

Laurence Mutkin, Global Head of G10 Rates Strategy at BNP Paribas, lists down the two reasons that global bond yields have continued the upward march they began in the summer, notwithstanding risk events which have surprised markets (most recently the Italian referendum and the ECB’s new QE recipe).

Key Quotes

“First, inflation breakevens remain well below their historic averages even though “the risk of deflation has largely disappeared”, as ECB President Draghi put it at the December ECB press conference.”

“Second, term premium remains extremely low, even at the front end of yield curves: we expect that after December’s FOMC, US term premium will continue to rise to reflect the prospect for higher growth, inflation and bond supply over the next couple of years.”

“As far as the Eurozone is concerned, our economists’ call regarding a change in PSPP parameters and extension proved right. On the expected three implications of today’s ECB announcement: i.e. steeper curves, tighter long-dated ASW and higher long term rates, the first two have occurred already. For the third one, we believe that the relative stability of Bund yields will prove temporary as real yields will have to adjust higher.”

“Hence – notwithstanding the pace of the sell-off – we maintain our recommendations to be short duration in the US and to have curve steepeners in the euro area, Japan, the UK and Australia. At present market levels, risks around the outlook for interest rates and inflation remain asymmetrically tilted to the upside.”