Search ForexCrunch

The recent escalation of Trump- and trade-related risks has left its mark on financial markets  with shaky equity markets and slightly lower long bond yields as a result, notes the analysis team at Nordea Markets.  

Key Quotes

“While it is hard to predict the upcoming run of events in the trade war, we are reluctant to call a peak in the tensions yet. Tensions between China and US as well as Europe and the US seem to be on the rise still. And the risk of asymmetrical retaliation measures from China (such as prohibiting sales of certain US goods in China) should not be ruled out. This is an obvious downside risk for long bond yields and equity valuations compared to our predictions.”

“In the midst of the ongoing trade tensions, the Fed continues to lift the anchor of the USD curve via quarterly rate hikes. If the market were to price in between six or seven hikes in total in 2018-2019 from the Fed (as signalled by the Fed’s dot plot and Nordea’s forecast of a total of seven hikes),  the “fair value” of the 10yr treasury yield should move to the range of 3.25-3.50%.  However, the trading war fog needs to dissipate for the long end of the yield curve to move into that range and we have yet to see any signs of that.”

“It is our impression that a substantial downturn in US key figures is needed to change the current course of the Fed, which seems to be on autopilot with quarterly rate hikes and the running balance sheet unwind that should reach maximum speed in Q4 2018.”

“The unwinding of the Fed’s bond portfolio will likely start to have an increasing impact on financial markets  as we approach the maximum speed of 50bn per month in late 2018 (side-effects are already seen in Emerging Markets and in USD money market rates).  It is also our impression that the unwinding of the bond portfolio will lead to a further flattening of the USD curve into 2019. An inversion of the 2s10s spread cannot be ruled out during 2019.”