Just weeks into 2018, banks rethink year-end bond yield forecasts

By Dhara Ranasinghe and Fanny Potkin

LONDON (Reuters) - Little over a month into 2018 and several banks have already raised their forecasts for where key U.S. and European bond yields will end the year, another sign that the tide for bonds has turned as an era of easy monetary policy comes to an end.

While this week's global equity rout has driven investors to seek safety in bonds and pushed yields sharply lower, that is just a sign that the march higher in borrowing costs will not be a straight line upwards.

It has done nothing to change analysts' minds that the only way for yields is up.

On Tuesday, HSBC told clients that it now forecasts German Bund yields to end the year at 0.90 percent from a previous estimate of 0.60 percent.

It joins a series of banks - UBS, Deutsche Bank, JP Morgan, Mizuho, Commerzbank and HSBC - which over the past three weeks have revised U.S. or European bond yield forecasts higher.

Other banks such as ABN AMRO and Rabobank said they were in the process of revising their forecasts against the backdrop of a faster-than-anticipated rise in bond yields at the start of the year.

U.S. 10-year Treasury yields rose to four-year highs at around 2.89 percent this week, while German equivalents climbed to their highest in more than two years.

"The bearish momentum in bonds has surprised us," said Richard McGuire, head of rates strategy at Rabobank in London. "The reason the selling pressure was more pronounced this year is that the arguments in favour of higher yields are numerous."

Another large European bank told Reuters it had revised its U.S. bond yield forecasts higher but was unable to disclose details due to regulatory factors.

Swiss bank UBS expects 10-year bond yields in Germany, the euro zone's biggest economy and its benchmark bond issuer, to end the year at 1 percent versus a previous forecast of 0.90 percent.

It has raised year-end U.S. 10-year Treasury forecasts by 0.2 percent to 2.90 percent, while Deutsche Bank estimates Treasury yields could rise to 3.25 percent, upping its previous forecasts of 2.95 percent.

Robust economic data, a pick up in inflation expectations and hawkish central bank talk have prompted investors and analysts to reassess the outlook for bonds.

Even after this week's recovery in bond markets, 10-year yields in Germany and the U.S. are 26-30 basis points higher compared with where they ended last year.

Those rises are significantly higher than comparable moves in the first six weeks of 2017, setting the backdrop for the rethink on bond forecasts so early in the new year.

JPMorgan in mid-January raised its forecast of 10-year U.S. bond yields to 2.85 percent from 2.70 percent.

For Europe, the rises in bond yield forecasts were generally more modest, reflecting caution about inflation, which remains below the European Central Bank's near 2 percent target.

ING lifted its year-end German Bund forecast by a modest 0.1 percent to 0.85 percent.

HSBC and Mizuho said a pricing in of higher interest rates by euro zone money markets was the main reason for upward revisions to bond yield forecasts in Europe.

Forward money market rates suggest a 10 basis point rate rise from the ECB is priced in for early 2019.

"Market expectations for a rate hike are more aggressive than what we think is likely," said Peter Chatwell, head of rates strategy at Mizuho.

"But unless the ECB massively downgrades its inflation forecasts at upcoming meetings, it's unlikely the rate-hike risk-premium will be priced out by markets."

(Additional reporting by Hideyuki Sano in TOKYO; Editing by Matthew Mpoke Bigg)