December 10, 2015 / 3:21 PM / 3 years ago

Sovereign bonds to remain in demand, say strategists: poll

(Reuters) - Major sovereign bonds will remain in demand next year, with yields rising only modestly, partly because very low inflation rates are expected to persist for some time, a Reuters poll found on Thursday.

Traders work at their desks in front of the DAX board at the Frankfurt stock exchange March 18, 2013. REUTERS/Remote/Janine Eggert

There is also a risk that global economic growth remains lackluster next year or that the slowdown in emerging economies morphs into a bigger threat. That may keep many central banks pursuing ultra-easy monetary policy and bonds well bid.

The latest 12-month U.S. 10-year Treasury yield US10YT=RR forecasts are about 50 basis points above where they are trading now — nearly identical to the rise in yields forecast by the same strategists two years ago.

Then, the Federal Reserve had only started to ease off on its trillions of dollars of quantitative easing stimulus through government bond purchases - whereas the Fed is now seen on the brink of raising rates, for the first time in a decade, on Dec. 16.

For years, bond strategists have been predicting a return to the yield curve norm before the financial crisis of 2008, driven by a bias that says stimulus must lead to future inflation, and so, higher yields.

This time, a majority said in reply to an additional question the risks to their forecasts were to the downside.

“If there is one thing we can be sure about, consensus bond yield forecasts are unlikely to be right. This follows decades of over-optimism bias and, while history is no guide to the future, it does provide grounds for scepticism,” wrote Steven Major, global head of fixed income research at HSBC.

Major is one of the most accurate bond yield forecasters based on recent performance and is the only one of a panel of some 60 bond market strategists, including the primary bond dealers, who correctly predicted the fall in yields last year.

He is again going against the crowd. He expects a fall of about 70 basis points in 10-year Treasury yields to 1.50 percent by end-2016, 125 basis points lower than the consensus.

Yet expectations remain rock-solid for the Fed to lift interest rates next week. [FED/R]

Two-year U.S. Treasury yields, which are particularly sensitive to near-term expectations for the fed funds rate, are forecast to rise over 80 basis points to 1.74 percent in a year, according to the poll.

But analysts remain cautious about the outlook for inflation and growth. That suggests that while the Fed’s first rate hike next week is priced in, doubts remain on just how quickly the Fed will be able to follow up on that first move.

“Looking beyond the widely anticipated start of U.S. tightening, we wonder what will happen if the rate hikes do not stick,” HSBC’s Major wrote.

A separate Reuters poll showed the Fed will move very gradually next year after it delivers the first hike in December driven by a tame inflation outlook. It is not expected to start selling any of its bond holdings next year. [ECILT/US]

But unlike the Fed, the European Central Bank will continue to keep policy easy for years as the euro zone recovery is by no means guaranteed yet and inflation there is set to remain well below target. [ECILT/EU]

The euro climbed after the ECB cut its deposit rate cut by 10 basis points and an extension to its 60 billion euros ($66 billion) of monthly asset purchases, disappointing expectations for more radical action.

With the ECB planning to expand its balance sheet by more than a trillion euros through mainly sovereign bond purchases, German two-year Schatz yields are expected to remain negative in the coming year. German 10-year yields are expected to rise over 40 basis points to 1.00 percent in a year.

But not all forecasters are sounding chastened by misses in past years, instead calling for a snap-back in yields.

“The euro rates market sell-off after the ECB’s underwhelming December easing is a chilling reminder that, without incremental central bank easing, bond valuations are unsustainably poor,” according to Laurence Mutkin, global head of G10 rates strategy at BNP Paribas.

“Treasury valuations are also unsustainable, especially in an environment where the Fed is hiking.”

UK Gilt yields are expected to rise along with a steady improvement in the economy and expectations for an interest rate hike from the BoE by the middle of next year. Like the Fed, the BoE has no intention of selling its vast bond holdings any time soon. [ECILT/GB]

($1 = 0.9126 euros)

Additional reporting and analysis by Hari Kishan; Polling by Sarmista Sen and Deepti Govind; Editing by Ruth Pitchford

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