Chairman Bernanke has always indicated that the end of QE would be a gradual affair rather than a big bang shock. We believe this tapering will commence at the September 2013 FOMC meeting. And the winding down of the asset purchase program will end completely by mid-2014. Any increase in the fed funds rate, however, is unlikely before mid 2015.
The QE approach depressed real bond yields and the term premium. Some of this impact has unwound now that the Fed has signalled its intentions. Calibrating just how much further and how quickly real bond yields will rise is difficult. Factors such as US fiscal tightening and Europe’s malaise point to lower real yields than in the past. Well-anchored inflation expectations make comparisons with the 1994 bond market rout largely erroneous (though the Fed will need to continue to demonstrate its low inflation credentials). We expect 10-year Treasury yields to settle in a 3-3½% range in 2014. Australian bond yields should rise by less – the RBA maintains an easing bias and the relative growth gap should close. We expect 10-year ACGB’s to move slowly towards 4½% in 2014.
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