Era of low sovereign yields not ending, even if Fed hikes: poll

By Rahul Karunakar

(Reuters) - The long era of low sovereign bond yields has at least another year to run as falling inflation and a weak global economic outlook will prevent them from rising much even after the Federal Reserve begins hiking rates, a Reuters poll found.

Bond strategists and economists have for years been predicting higher yields that have still not materialised, and after the Fed held off raising its federal funds rate this month, many now doubt a U.S. rate hike will happen this year.

In a speech late on Thursday, Fed Chair Janet Yellen said the central bank was still on track to raise interest rates this year, pushing up the dollar and U.S. Treasury yields. But the market reaction was relatively mild.

This time last year, U.S. Treasury yields were expected to have risen significantly by now on expectations the Fed would begin raising interest rates sometime in 2015.

But the latest poll of over 50 bond strategists, taken Sept 21-24, showed they have tempered their forecasts, expecting bond yields to stay low for longer. A few predict significantly lower major sovereign yields.

"The Fed decision improved the environment for core bonds and there is currently little, if any, potential upward pressure on yields coming from the monetary policy stance of ...the G3 central banks," wrote Luca Cazzulani, senior fixed income strategist at UniCredit.

Strategists are still clinging to the view the U.S. Treasury yield curve will normalise just as they expect U.S. monetary policy to eventually return to something similar to what it was before the financial crisis.

Most global policymakers remain either neutral or are in easing mode - the central banks of Taiwan, Norway and Ukraine were the latest on Thursday to cut rates.

The two-year U.S. Treasury note yield, which is particularly sensitive to near-term expectations for the fed funds rate, is expected to rise to 1.00 percent by end-2015 from the current 0.73 percent, and reach 1.70 percent in a year, according to the poll.

So strategists still think the fed funds rate will rise soon, despite the fact that the market is only assigning about a one-in-three chance that will happen by year-end - similar to the probability it attached to a September hike just before the decision.

The 10-year U.S. yield, which is more sensitive to the long-run outlook for inflation, is forecast to rise much less, to 2.75 percent in a year from 2.15 percent earlier on Thursday, suggesting a much flatter yield curve.

A smaller sample of strategists who answered an extra question said the outlook for further disinflationary pressures and continued weakness in emerging markets were the biggest risk to their yield forecasts.

They also concluded that prolonged lower sovereign bond yields could lead to higher stock prices or extreme currency movements.

LOWER HIGHS AND EVEN LOWER LOWS

A breakdown of the range of contributions in the latest poll shows the highest yield forecast is lower compared with three months ago and the lowest forecast is significantly lower.

That, at minimum, shows that bond strategists are less confident that inflation will eventually pick up as Fed chief Janet Yellen and the Federal Open Market Committee hope.

"Yellen gave little sense of confidence that the Fed would meet its inflation mandate, and cited global economic and financial developments – a veiled reference to the dollar – as acting as a drag to growth and inflation," wrote Antoine Gaveau, associate rates strategist at JP Morgan.

Much of the reason markets are now hesitating on a Fed rate rise is attributed to weak global demand and falling inflation around the world, as well as worries that the slowdown in emerging economies might morph into a bigger threat.

The euro zone's fledgling recovery is also at risk with the euro climbing again and the economy in China, one of its most important trading partners, slowing down.

European Central Bank President Mario Draghi told European lawmakers on Wednesday that the emerging market pullback has increased the risk to Europe's inflation and growth outlook. But he added the bank would need more time before deciding to ease policy any further.

With the ECB expanding its balance sheet through mainly sovereign bond purchases, German two-year Schatz yields are expected to remain negative in the coming year.

Forecasts for two-year Gilt yields suggest an interest rate hike from the Bank of England in the first quarter of next year.

That is in line with the latest Reuters poll of economists on BoE monetary policy, but the interest rate futures market is not pricing in the first rise until the second quarter.

In the latest poll, the two- and 10-year Gilt yield spread is forecast to narrow in the coming year, suggesting a subdued long-term inflation outlook.

(Additional reporting by Hari Kishan; Polling and analysis by Aara Ramesh and Anu Bararia; Editing by Ross Finley and John Stonestreet)

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