Beyond the Headlines | 13 Oct 2023

Long-term forward rates have risen too far

Ben May

Director, Macro Forecasting & Analysis

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We’ve recently revised up our forecasts for US and UK bond yields in the long term by 50 basis points; we’ve also revised up Japanese and German yields by 20 to 25 basis points.

In this week’s Beyond the Headlines join Ben May, Director, Macro Forecasting and Analysis, as he discusses the recent rise in government bond yields.

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Hello. My name’s Ben May from Oxford Economics, and I’m here to talk today a little bit about the recent rise in government bond yields. So we’ve recently revised up our forecasts for US and UK bond yields in the long term by 50 basis points. We’ve also revised up Japanese and German yields by 20 to 25 basis points. Even so, we still think that the market implied forward rates for 5 to 10 years time, which have risen considerably, look much too high for the major advanced economies.

True, we expect sticky inflation to only prompt a gradual reduction of policy rates by the Fed and other major central banks over the next couple of years or so. But in our opinion, the pickup in long term forward rates has gone too far and is likely to be reversed somewhat as inflation falls back to target and global growth softens.

We think that the long term real neutral interest rate is likely higher than prior to the pandemic, but we’re skeptical that there’s been a substantial increase. Markets seemingly think real neutral interest rates are rather higher than our own analysis implies is likely. We’re also sympathetic to the view that inflation will be more likely to have periods above target over the next decade than during the 2010s.

But we still expect inflation and inflation expectations to remain anchored to central banks targets. And even allowing for higher term premia to reflect factors, such as greater inflation risk and in some economies the weaker position of the public finances, we think the considerable rise in long term market forward rates over recent months looks like an overreaction.