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Bond yields surge, some gains to endure: Oxford Economics

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By Charbel Kadib
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3 minute read

Long-term yields would likely retain more of their recent gains than initially anticipated, Oxford Economics has claimed, following the latest spike in the bond market.

In what has been described by ANZ as a “wild” day in the bond market, 10-year US Treasury bond yields surged to as high as 5.02 per cent on Monday (23 October) before settling at 4.84 per cent.

Yields have been tracking higher over the past week amid expectations of more monetary policy firming from central banks aimed at accelerating disinflation.

Australian 10-year government bonds have followed suit, rising to a peak of 4.8 per cent over the past week before moderating to just over 4.7 per cent.

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According to Sean Langcake, head of macroeconomic forecasting at Oxford Economics, Australian bond yields would likely retain some of the recent growth following an expected correction in the short-medium term.

Oxford Economics has revised up its forecast for long-term yields by 50 bps.

“Bond markets have moved around sharply this year and we think a good deal of the spike in yields will be unwound in time,” he said.

“Nevertheless, some of the increase is driven by changing fundamentals, which warrants a change in our outlook.”

He said the outlook for the two key drivers of bond yield movements – expectations for the path of policy rates and term premia – suggests the expected moderation in yields would be less pronounced than initially anticipated.

“Both globally and in Australia, our assessment is that markets are overstating the level at which policy rates will settle in the long run,” Mr Langcake continued.

“In Australia, market expectations for the policy rate 10 years forward sat around our estimate of the neutral rate (2.6 per cent) for much of the 2010s.

“The sustained period of low inflation prior to the pandemic contributed to a dip in expectations leading into the pandemic, but the forward rate has subsequently risen to around 3.5 per cent.”

In assessing the outlook for term premia, Mr Langcake said he expects compensation levels to “remain elevated”, underpinned by “inflation volatility” over the long term.

“Central banks have had greater difficulty achieving their inflation targets since the 2010s, initially undershooting targets in the lead up to the pandemic, and subsequently struggling to rein in inflation,” he added.

“In addition, while we expect inflation targets will be met on average, supply shocks look set to generate greater inflation volatility in the coming decades. De-globalisation and climate risks loom as the largest threats here.

“In this world, it makes sense for investors to demand a higher inflation risk premium when holding longer-term debt.”

Upward pressure on term premia, he added, would also be driven by the unwinding in asset purchasing programs from central banks after a marked ramp up at the height of the COVID-19 pandemic.

Oxford Economics has increased its forecasts for term premia to approximately 85 bps and now expects the 10-year government bond yield to settle at 3.4 per cent.

Bond yields surge, some gains to endure: Oxford Economics

Long-term yields would likely retain more of their recent gains than initially anticipated, Oxford Economics has claimed, following the latest spike in the bond market.

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