Global weekly: More divergence ahead

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ABN AMRO Private Banking, Expertise, Investments, Treasury and special products, Forex

Central banks continue to dominate markets. In December, the paths of the European Central Bank and the US Federal Reserve will further diverge, as the ECB adds to its accommodating monetary policy and the Fed hikes rates for the first time since 2006.

Bond markets update
Financial markets seem to be prepared for the first Federal Reserve (Fed) rate hike in December. The probability of a rate hike priced in by markets has risen from below 25% to 70% in just three weeks. Last week’s US labour market report for October is seen as a game changer. Additional hints from Federal Reserve policymakers added to the probability. We think that after the Fed lift-off in December, the pace of the following rate hikes will be slow. We expect the Fed policy rate to reach 0.5% in December 2015. The next hike will be in June, giving the Fed more time to assess the impact on the US economy, followed by hikes every other meeting reaching 1.25% at year-end 2016. If this scenario plays out as we expect, US Treasury yields reach 2.5% at year-end 2015 and 3% at year-end 2016.

Markets currently seem to be ignoring that most other central banks are not following the Fed’s direction. The European Central Bank (ECB) may expand its asset purchasing programme further in December and the Bank of Japan and the Peoples Bank of China are both still in accommodative policy mode. Also, the Bank of England (BoE) made clear that the UK will not follow the US in the coming months. The BoE could keep European government bonds stable when the ECB adds to its asset purchasing programme. This week, 10-year US Treasury yields rose to 2.31%, which is almost the same level as in September, but lower than in the summer when it approached 2.5%. Corporate credit spreads could benefit from the current momentum as corporates try to benefit from the current low interest rate. This momentum could fade towards the end of the year, due to lack of market liquidity and given the expectation for a hike in rates by the Fed.

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