Looking ahead to 2019

  • 10.Dec.2018
  • Ian Martin,  XTB

Bond market outlook for 2019

A key piece of the puzzle to forecasting 2019 will be put in place when the Federal Reserve meets on 20 December.

Despite the Fed Chairman’s recent comments which are interpreted as dovish, I still expect the fourth 0.25% rate hike to occur taking the upper band of the overnight rate to 2.50%.

Key points

  • US 10-year bond to reach 3.75%, up 0.75% from current levels
  • At least 2 more rate hikes by Fed to 3.00% after the expected move in December
  • AUD 10-year bond will possibly move 50bp higher but not as high as the US 10-year bond
  • RBA expected to remain on hold during 2019
  • AUD 3-year bond continue to trade in a range closely tied to RBA rate.

The Feds will continue to raise rates

I would anticipate at least two more hikes by the Fed in 2019 to take the rate to 3.00%; and therefore a total of 0.75% increase from current levels. The benchmark US 10-year government bond’s yield will be affected by this. The 10-year bond yield could be around 3.75% or up nearly a 0.75% from current levels but only an increase of 0.50% from highs seen during 2018.

Will 4.00% be a reality? Probably not

There are several reasons why I do not see treasuries breaking through 4.00%. Any rapid rise in interest rates can cause stress in risky asset classes i.e., equities. When equities sell off, short term flights to safety occur as institutional asset allocators buy bonds. Also, it is not uncommon the see the yield curve at its flattest at the end of the tightening cycle.

What was clear from the Fed Chairman’s latest comments is that the FOMC (part of the Fed that decides on the Fed Funds rate) will become much more data dependent as they approach a neutral level for interest rates. This could introduce more volatility as markets react to every new data point. This increased volatility may also affect the pricing of risky assets and increase appetite for fixed income.

Some risks challenging the above view is that there is increasing supply from government new issuance as the deficit increases. Data, particularly inflation, spikes higher and there is also a potential buyer strike from participants such as China who may wish to flex their own influence on trade and geopolitical outcomes.

RBA will remain on hold, but for how long?

In Australia, the RBA is expected to remain on hold for 2019. During that time, 3-year government bonds will trade in a range as they are more closely tied to the RBA rate. 10-year bonds will be more affected by US bond rates.

It is possible we will see yields move higher, possibly 50 bps higher, but they will not rise as much as US rates. This implies a steeper yield curve in Australia. It is not uncommon to see a steep yield at the start of a central bank tightening cycle.

Credit could easily under-perform, but I would expect emerging market and non-investment grade bonds to be the most affected.

The information in this article is general in nature. It should not be the sole source of information. It does not take into account the investment objectives or circumstances of any particular investor. You should consider, with or without advice from a professional adviser, whether an investment is appropriate to your circumstances. Australian Corporate Bond Company Limited is the Securities Manager of XTBs and will earn fees in connection with an investment in XTBs.


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