Bank of the West US Outlook Report for June 5, 2015

Bank of the West US Outlook Report: Fixed Income Markets On the Move

We are seeing a dramatic sell-off in global fixed income markets that it appears is driven by vigorous selling of Eurozone sovereign bonds, but is also spilling over into the U.S. and elsewhere around the world.  Indeed in the last week alone, the U.S. 10-Year Treasury bond yield has moved up 25 basis points or 0.25 percentage points. Thirty-year fixed-rate mortgages are following suit and mortgage rates are on the rise. In this week’s report, I explore in more detail what might be behind this dramatic sell-off and what the implications could be for the FOMC, and the timing and pace of Federal Reserve interest rate hikes.

The calm and complacency that has held sway in the global bond market since January when the ECB announced its own QE program is beginning to unravel.  A quick look at global bond yields reveals the epicenter of the selling has originated in Europe with the 10-Yr German bund jumping from around a 0.07 percent yield on April 20th to a peak of 0.99 percent earlier today.


Why is the sell-off happening now?

Fixed-income valuations appear rich in this economic environment.  The global deflation scare around plunging oil and commodity prices is unwinding. Fear of a Greek exit is also being unwound. At the same time, the Fed is about as close to raising short-term interest rates for the first time in more than nine years as it can get.  There is rising concern about the functioning of global bond markets. Some prominent folks have voiced concerns about diminishing bond market liquidity and the risk that a financial market shock or Fed liftoff could exacerbate or even create sudden moves in long-term interest rates.

Implications for the Fed: I see the Federal Reserve reducing their economic growth forecasts for 2015 and perhaps even for 2016 or 2017 from their March forecast. I suspect a flatter dot-plot than we had at the March meeting.  The Fed should initiate their crawl to normalization at the September FOMC meeting, but the next rate hike might not happen until January 2016.  My estimate of the Fed funds target rate at the end of 2016 is now about 25 basis points lower than my estimate from a few months ago.


To find out more, check out this week’s Outlook Report.

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