Interest Rate Outlook: U.S. Treasuries Likely To Be Stuck Between Better-Than-Expected Growth And A Dovish Fed

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Includes: BIL, BNDX, BWX, DFVL, DFVS, DLBS, DTUL, DTUS, DTYL, DTYS, EDV, EGF, EUFL, EUFN, FIBR, GBIL, GIM, GOVT, GSY, HYDD, IEF, IEI, IGOV, ITE, PLW, PST, RISE, SCHO, SCHR, SHV, SHY, TAPR, TBF, TBT, TBX, TLH, TLT, TMF, TMV, TTT, TUZ, TYBS, TYD, TYNS, TYO, UBT, UST, VGIT, VGLT, VGSH, VUSTX, ZROZ
by: Invesco US
Summary

In the near term, we expect Treasury yields to be stuck between better-than-expected growth and a dovish Federal Reserve.

Euro area economic data point to another weak quarter of growth in the fourth quarter of 2018, with much of the unexpected deterioration coming from trade and business confidence.

We are neutral on Chinese interest rates due to our expectation of supportive Chinese monetary and fiscal policies, potential investor shifts toward credit and US Treasury yield movements.

The Bank of Canada (BOC) reduced its growth estimate to 1.7% for 2019 and expects inflation to remain near its 2.00% target.

The market is currently pricing a 60% probability of a 25 basis-point cut by the Reserve Bank of Australia (RBA) this year.

Posted by Rob Waldner, Chief Strategist and Head of Multi-Sector on Feb 6, 2019, in Fixed Income

Invesco Fixed Income shares its views on rates around the world

Interest rate outlook: US Treasuries likely to be stuck between better-than-expected growth and a dovish Fed

US: Neutral.

In the near term, we expect Treasury yields to be stuck between better-than-expected growth and a dovish Federal Reserve. The Fed stated it will remain patient when considering future hikes and has noted concerns about a lack of persistent inflation. Over the longer term, we expect growth and inflation data to support a hike in June. While we continue to believe peak US growth is behind us, we expect it to remain above-potential through the first half of 2019. Inflation will likely remain benign in 2019, although labor costs may continue to accelerate. This could allow the Fed to continue its gradual path of policy normalization after a March pause.

Europe: Neutral.

Euro area economic data point to another weak quarter of growth in the fourth quarter of 2018, with much of the unexpected deterioration coming from trade and business confidence. However, we believe economic sentiment will improve with the unwinding of adverse temporary factors, such as French protests and weakness in the German auto industry. Additionally, slowing inflation and robust employment should continue to support consumer confidence. We expect the European Central Bank to maintain its accommodative policy stance and dovish rhetoric and not meaningfully alter its assessment of growth and inflation in the near term. With markets not pricing the first rate hike until well into 2020, the bar for a more dovish repricing is high, in our view.

China: Neutral.

We are neutral on Chinese interest rates due to our expectation of supportive Chinese monetary and fiscal policies, potential investor shifts toward credit and US Treasury yield movements. We expect China's monetary policy to remain accommodative and fiscal easing to play a more active role going forward. In the medium term, liquidity will likely remain reasonably loose, but investors may cut interest rate positions and add risk via the credit market due to the recently announced series of supportive measures. US Treasury and Chinese equity market performance could be swing factors in the movement of Chinese onshore interest rates.

Japan: Neutral.

Japanese government bond yields have bounced since the start of 2019, in line with the move in US Treasury yields. However, valuations, especially of short-term bonds, still look stretched, in our view. Support from foreign US dollar-hedged buyers, who have been increasingly active in the market, could wane from here. However, downside risks to growth and inflation, reduced foreign bond alternatives and a sharp reduction in net supply should support long-term bonds, likely limiting the scope for an upward move in yields.

UK: Neutral.

The outlook for UK gilts is relatively mixed, in our view. In the near term, prolonged Brexit uncertainty will likely constrain the Bank of England (BOE) from hiking, limiting the chance of a front-end led selloff. However, moves towards a softer Brexit/no Brexit and increased fiscal risk premium (reflecting the risk of a Labour government) could weigh on long-term maturities, especially if combined with more global growth optimism. But lower net supply and substantial BOE quantitative easing reinvestment, especially in March, should constrain interest rates from moving substantially higher.

Canada: Neutral.

The Bank of Canada (BOC) reduced its growth estimate to 1.7%1 for 2019 and expects inflation to remain near its 2.00% target.2 Continued strong employment should help prevent a housing slowdown and large consumer debt balances from becoming bigger issues. Like other central banks, the BOC has backed away from the urgent need to raise interest rates, with any hikes not likely until later in the year. We do not see 10-year Canadian sovereign bond yields as attractive near current levels (around 2.00%3), but without a rise in inflation or a pickup in growth, the 10-year yield may not challenge the 2018 high of 2.60%.4

Australia: Neutral.

The market is currently pricing a 60% probability of a 25 basis-point cut by the Reserve Bank of Australia (RBA) this year.5 We believe this would be somewhat excessive given current economic data, but downside risks to growth have increased globally and domestically, leaving the RBA's November forecasts looking overly optimistic. We expect the RBA to downgrade its growth forecast at the February meeting and potentially adopt a more symmetric policy bias.

India: Overweight.

We have resumed our overweight position after tactically moving to neutral due to the Reserve Bank of India's (RBI) uncertain policy direction following its governor's abrupt resignation. We still find current yields attractive from a valuation perspective and see room for long-term interest rates to decline further in the near term, particularly for 10-year government bonds. In our view, several supportive factors will remain in place through the first quarter of 2019, including low inflation, RBI liquidity improvement measures and light debt supply.

1 Source: Bank of Canada, Jan. 9, 2019.

2 Source: Bank of Canada, Oct. 2016.

3 Source: Bloomberg L.P., Jan. 25, 2019.

4 Source: Bloomberg L.P., Oct. 5, 2018.

5 Source: Bloomberg L.P., Jan. 18, 2019.

Important information

Blog header image: Bill Perry/Shutterstock.com

Dovish refers to an economic outlook which generally supports low interest rates as a means of encouraging growth within the economy.

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer's credit rating.

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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Interest rate outlook: US Treasuries likely to be stuck between better-than-expected growth and a dovish Fed by Invesco US

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.