The interest rate on 10-year US Treasury bonds rose significantly in December. The market for government bonds of major industrial nations followed suit. Observers expect stable to slightly rising interest rates in 2011.

In 2010, the global economy managed to make up most of the losses occasioned by the financial crisis and the ensuing recession. However, economic growth was supported by several specific factors including government support packages, tax breaks and statistical basis effects. Most of those factors will disappear at the beginning of the year, and many investors are fearing a downturn.

Economic expectations push up long-term interest rates

In order not to threaten economic growth, the US government has decided to maintain the tax breaks until further notice. This has eliminated the fear of a relapse into recession, stirring hope that the economy might develop better than expected. As a result, the interest rate for 10-year Treasury bonds leapt by nearly 1% in December, up to well over 3%. Interest rates have thus entered a broader trading range and now lie between 3% and 4.25%. Clariden Leu, for example, no longer expects rates to fall below 3%.

Economic indicators are not only better than expected in the US. In Germany and in Asian countries too, especially China, there is renewed hope for an accelerated upturn. The market for government bonds of major industrial countries has followed US interest rate movements and now offers significantly higher yields. However, the sustainability of US fiscal policy is questionable, as is that of the Federal Reserve Bank's support measures, which is why Clariden Leu prefers “investment grade” corporate bonds to government bonds.

European government bonds involve risks

Uncertainty prevails with regard to most European government bonds. In December, the EU heads of state agreed on a durable mechanism for stabilising the Euro zone until 2013 and after. But the creation of common Euro-bonds has been ruled out for the time being. That would have enabled weaker EU Member States to rely on the stronger EU Member States when borrowing on capital markets. Observers believe that the EU has to push ahead towards political integration before it can develop a common economic policy with stable budgets. That process will last several years, so the imbalances and risk premium variances for the bonds of individual countries will continue to exist in the foreseeable future.

Money market rates to remain low

Short-term interest rate expectations remain subdued. To continue supporting economic growth, the Federal Reserve Bank as well as the European Central Bank and the Swiss National Bank decided not to increase key interest rates in 2010. The money market rate for Swiss francs (3-month LIBOR), which had dropped to 0.25% at the end of 2009, is now only 0.17%. There is a consensus that money market rates will rise in the coming 12 months, but the individual estimates vary from 0.25% to 0.9%. Most market players expect key interest rates to increase from the middle of 2011.

Source: Clariden Leu