US yields: Markets still priced too soft - Danske Bank

Analysts from Danske Bank still see a case for a Fed repricing next year in 2019 pushing 2Y yields higher. They continue to expect a flattening of the curve for the 2Y10Y on a 12M horizon.

Key Quotes: 

“As expected, the Fed raised the target range by 25bp to 1.25-1.50% at its December meeting. The Fed still signals three additional hikes next year and slightly more than two hikes in 2019. The longer-run median dot was unchanged at 2.75%.”

“Although uncertainty is higher than usual with a new Fed Chair and still many vacant seats in the Fed Board of Governors, Powell is considered to be in the same ‘neutral’ camp as Yellen. Consensus is calling for three hikes but we expect inflation to remain muted, so we are calling for one less in our base case scenario (although risk is currently skewed towards a third one, as the Fed puts more weight on labour market data than inflation).”

“Markets have nearly priced in two hikes in 2018 but more or less think the hiking cycle ends by the end of 2018 or early 2019. We disagree and think the hiking cycle has a little further to go and see two further hikes in 2019. Hence we still see a case for a Fed repricing next year in 2019 pushing 2Y yields higher. We continue to expect a flattening of the curve for the 2Y10Y on a 12M horizon. The short end is pushed higher by Fed rate hikes, while the long end could be kept low by investors buying ‘high yielding’ US fixed income assets, low inflation expectations and a lower neutral rate.”