| Consensus rate and forex forecasts : flat yield curve entrenched |
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| 29.04.2007 | |
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Steady as she goes. The slope of the yield curve in the eurozone should remain flat in the near-term according to a bfinance survey of ten economists. Eurozone long term interest rates remain remarkably low, which together with the ECB's successive rate hikes has led to a sharp decline in yield differentials over the past year. Indeed, the interest rate differential of the benchmark German government 10-year bond yield over the corresponding 2-year yield was just 4 basis points at the end of April compared to 64 basis points a year earlier. Normally the yield curve has a positive slope with long term interest rates higher than short term ones due to the risk premia associated with the uncertainty about future inflation. Yet the resilience of most eurozone economies, notably Germany's, has had two far-reaching effects: it has resulted in tight yield spreads and provided a crucial pillar of support to the euro. This scenario does not seem likely to reverse any time soon. The surveyed economists have retained their base rate forecasts. One exception is Merrill Lynch which has raised its Europe base rate forecast by 25 basis points to 4% at the end October from 3.75% last month (see chart). "We believe short end bonds will hold a strong rate hike risk premium as long as EMU data stays robust and ECB rhetoric hawkish," says Andrew Roberts, fixed-income strategist at Merrill Lynch. "We have not changed our inversion levels for 2 year bunds over 10-year bunds or for 10-year bunds over 30s. They will still move into inversion in coming months." Flat worldwide This structural flattening of the yield curve can be seen worldwide. Another force contributing to it is demand by pension funds for longer-dated fixed-income products. A number of economists in the survey expect a yield inversion, historically a harbinger of slower growth. Lehman Brothers is forecasting base rates in Europe to be 7 basis points higher at the end of October than 10-year rates. Europe's tightening bias is underpinned by the relative and expected strength of its economies relative to the US. "Following on the more upbeat mood reported by industrialists in Q1, French business confidence brightened up again in April, climbing to 111 from 109 registered in March," says Gustavo Reis, an economist at Lehman Brothers. "Strengthening of the euro and uncertainty surrounding the country's presidential elections is not distracting from business morale." The headline indicator for business confidence is 0.9 standard deviations above its long-term average, a six year high. According to Reis, French manufacturing continues to benefit from thicker order books on the back of Germany, its biggest trading partner. The economic barometer in the US is more worrisome. Merrill has accordingly dropped its base rate forecast six months out by 25 basis points. Federal Reserve chairman Ben Bernanke has acknowledged that downside risks to economic growth have increased. One area of clear weakness is in unemployment claims which are having a dampening effect on labour markets. As a result, the yield curve, which had been inverted for almost a year, has regained a more upwards slope. Two beneficiaries of tightening expectations in Europe are the euro and sterling (GBP). "European currencies are indeed strong but so are the economies," says Nikolaos Panigirtzoglou, global market strategist at JP Morgan. "The underperformance of the US economy has been a profitable theme for more than six months now. Recent economic data suggest that US underperformance is still underway, with the spike in gasoline prices providing a new headwind." This view is broadly reflected in the forecasts. A number of the surveyed economists expect the dollar to continue its slide against the euro. Natixis sees the euro/dollar exchange rate at 1,38 six months out compared to 1,33 from a month earlier. VB  |
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