THE YIELD CURVE

François Dupuis, Vice-President and Chief Economist Mathieu D’Anjou, Senior Economist • Benoit P. Durocher, Senior Economist • Francis Généreux, Senior Economist • Hendrix Vachon, Senior Economist

Desjardins, Economic Studies: 514-281-2336 or 1 866-866-7000, ext. 5552336 • desjardins.economics@desjardins.com • desjardins.com/economics

NOTE TO READERS: The letters k, M and B are used in texts and tables to refer to thousands, millions and billions respectively.IMPORTANT: This document is based on public information and may under no circumstances be used or construed as a commitment by Desjardins Group. While the information provided has been determined on the basis of data obtained from sources that are deemed to be reliable, Desjardins Group in no way warrants that the information is accurate or complete. The document is provided solely for information purposes and does not constitute an offer or solicitation for purchase or sale. Desjardins Group takes no responsibility for the consequences of any decision whatsoever made on the basis of the data contained herein and does not hereby undertake to provide any advice, notably in the area of investment services. The data on prices or margins are provided for information purposes and may be modified at any time, based on such factors as market conditions. The past performances and projections expressed herein are no guarantee of future performance. The opinions and forecasts contained herein are, unless otherwise indicated, those of the document’s authors and do not represent the opinions of any other person or the official position of Desjardins Group. Copyright © 2018, Desjardins Group. All rights reserved.

Bond Yields Poised to Keep Climbing

ECONOMIC STUDIES | MAY 3RD, 2018

HIGHLIGHTS

f After some hesitation, the U.S. 10-year yield recently broke through the psychological barrier of 3.00%, reaching its highest level since 2011. The rise in yields for shorter terms also continued, with the U.S. 2-year yield now over 2.50%. This uptrend in bond yields is supported by the Federal Reserve’s (Fed) upbeat tone, which clearly signalled its intention to pursue, and possibly speed up, its monetary tightening. The deterioration in U.S. public finances, which signals a surge in bond issuance, also justifies higher yields.

f The results of the national accounts confirmed that the U.S. economy had cooled, with the first quarter posting relatively slow growth of 2.3%. That said, this mixed performance is not a concern as it comes on the heels of a particularly strong end of 2017 for domestic demand, with all signs pointing to more energetic consumption growth in the second quarter. Climbing U.S. inflation is also worth noting; the annual change in the personal consumption expenditure deflator reached 2% in March while the core index was up 1.9%.

f The Bank of Canada (BoC) opted to maintain the status quo in April, for the second straight meeting. Nonetheless, the BoC maintains that the economic outlook remain positive, while upside pressures on inflation appear to be taking hold. Rising inflation and wage growth are bolstering the BoC’s viewpoint that higher interest rates will be justified over time, but caution still needs to be exercised. The 0.4% jump in Canada’s monthly GDP in February also suggests that a new key rate hike could be announced shortly. The BoC’s optimistic tone and encouraging developments in the trade negotiations with the United States have caused Canadian bond yields to spike in recent weeks.

f The monetary authorities on the other side of the pond seem more hesitant to tighten their monetary policy. Mixed economic data for Europe means that there is a slimmer chance the European Central Bank will quickly drop its securities purchasing policy. The interest rate hike expected in the United Kingdom for May seems far less likely today, with inflation falling and very weak growth in the first quarter. Furthermore, the Bank of England Governor has said that there was no rush to order another interest rate hike.

INTEREST RATE FORECASTS

f A new key rate increase in the United States should be ordered in June. The big question is whether the Fed will order a total of three or four 0.25% increases in 2018. For the moment, we are sticking with our scenario of three increases, but both assumptions are nearly equally probable.

f Two additional key rate increases before the end of 2018 are also expected in Canada. The BoC’s optimistic tone opens the door to a rate hike in May, but the monetary authorities seem more likely to wait until July. Continued monetary tightening in North America and rising inflation support our scenario of rising bond yields. Our targets for the 10‑year yield by the end of 2018 remain at 3.25% in the United States and 2.75% in Canada.

#1 BEST OVERALLFORECASTER - CANADA

ECONOMIC STUDIES

2MAY 2018 | THE YIELD CURVE

Q1 Q2 Q3 Q4 Q1 Q2f Q3f Q4f Q1f Q2f Q3f Q4f

United StatesFederal funds 1.00 1.25 1.25 1.50 1.75 2.00 2.25 2.25 2.50 2.75 3.00 3.00

CanadaOvernight funds 0.50 0.50 1.00 1.00 1.25 1.25 1.50 1.75 1.75 2.00 2.25 2.25

Zone euroRefinancing rate 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.05 0.25 0.25 0.50

United KingdomBase rate 0.25 0.25 0.25 0.50 0.50 0.50 0.75 0.75 0.75 0.75 0.75 0.75

JapanMain key rate -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10 -0.10

f: forecastsSources: Datastream and Desjardins, Economic Studies

TABLE 1Key interest rates

END OF PERIOD IN %

2017 2018 2019

Q1 Q2 Q3 Q4 Q1 Q2f Q3f Q4f Q1f Q2f Q3f Q4f

UNITED STATESTreasury bills

3-month 0.76 1.03 1.06 1.39 1.73 2.00 2.15 2.20 2.45 2.65 2.85 2.90Federal bonds

2-year 1.24 1.37 1.49 1.88 2.27 2.55 2.65 2.70 2.85 3.00 3.05 3.155-year 1.92 1.88 1.92 2.19 2.55 2.85 3.00 3.05 3.15 3.20 3.25 3.3010-year 2.40 2.30 2.33 2.41 2.75 3.05 3.20 3.25 3.35 3.40 3.45 3.4530-year 3.02 2.84 2.86 2.74 2.97 3.25 3.40 3.45 3.55 3.60 3.65 3.70

Yield curve slopes5-year - 3-month 1.16 0.85 0.86 0.80 0.82 0.85 0.85 0.85 0.70 0.55 0.40 0.4010-year - 2-year 1.16 0.93 0.84 0.53 0.47 0.50 0.55 0.55 0.50 0.40 0.40 0.3030-year - 3-month 2.26 1.81 1.80 1.35 1.24 1.25 1.25 1.25 1.10 0.95 0.80 0.80

CANADATreasury bills

3-month 0.52 0.71 1.00 1.06 1.10 1.30 1.55 1.75 1.80 2.05 2.25 2.25Federal bonds

2-year 0.75 1.10 1.52 1.69 1.78 2.05 2.15 2.25 2.30 2.45 2.50 2.605-year 1.12 1.40 1.75 1.87 1.97 2.25 2.40 2.50 2.55 2.65 2.70 2.7510-year 1.62 1.77 2.10 2.04 2.09 2.45 2.65 2.75 2.80 2.85 2.90 2.9030-year 2.30 2.15 2.47 2.26 2.23 2.55 2.75 2.90 2.95 3.00 3.05 3.10

Yield curve slopes5-year - 3-month 0.60 0.69 0.75 0.81 0.87 0.95 0.85 0.75 0.75 0.60 0.45 0.5010-year - 2-year 0.88 0.67 0.58 0.36 0.32 0.40 0.50 0.50 0.50 0.40 0.40 0.3030-year - 3-month 1.78 1.44 1.47 1.20 1.13 1.25 1.20 1.15 1.15 0.95 0.80 0.85

Yield spreads (Canada—United States)3-month -0.24 -0.32 -0.06 -0.33 -0.63 -0.70 -0.60 -0.45 -0.65 -0.60 -0.60 -0.652-year -0.49 -0.27 0.03 -0.20 -0.49 -0.50 -0.50 -0.45 -0.55 -0.55 -0.55 -0.555-year -0.80 -0.48 -0.17 -0.32 -0.59 -0.60 -0.60 -0.55 -0.60 -0.55 -0.55 -0.5510-year -0.77 -0.53 -0.23 -0.37 -0.65 -0.60 -0.55 -0.50 -0.55 -0.55 -0.55 -0.5530-year -0.71 -0.69 -0.38 -0.48 -0.74 -0.70 -0.65 -0.55 -0.60 -0.60 -0.60 -0.60

f: forecastsSources: Datastream and Desjardins, Economic Studies

TABLE 2Fixed income market

END OF PERIOD IN %

2017 2018 2019

3MAY 2018 | THE YIELD CURVE

ECONOMIC STUDIES

Schedule 2018 of Central Bank Meetings

NOTE: Certain banks may decide to change rates in-between the scheduled meetings. The abbreviations s.q. and b.p. correspond to status quo and basis points respectively.

Date Central banks Decision Rate

17 Bank of Korea s.q. 1.5017 Bank of Canada +25 b.p. 1.2522 Bank of Japan s.q. -0.1025 European Central Bank s.q. 0.0025 Bank of Norway s.q. 0.5031 Federal Reserve s.q. 1.50

5 Reserve Bank of Australia s.q. 1.507 Reserve Bank of New Zealand s.q. 1.757 Bank of Brazil -25 b.p. 6.758 Bank of England s.q. 0.508 Bank of Mexico +25 b.p. 7.50

14 Bank of Sweden s.q. -0.5026 Bank of Korea s.q. 1.50

5 Reserve Bank of Australia s.q. 1.507 Bank of Canada s.q. 1.258 European Central Bank s.q. 0.008 Bank of Japan s.q. -0.10

15 Bank of Norway s.q. 0.5015 Swiss National Bank s.q. -0.7521 Reserve Bank of New Zealand s.q. 1.7521 Bank of Brazil -25 b.p. 6.5021 Federal Reserve +25 b.p. 1.7522 Bank of England s.q. 0.50

3 Reserve Bank of Australia s.q. 1.5011 Bank of Korea s.q. 1.5012 Bank of Mexico s.q. 7.5018 Bank of Canada s.q. 1.2526 European Central Bank s.q. 0.0026 Bank of Sweden s.q. -0.5026 Bank of Japan s.q. -0.10

1 Reserve Bank of Australia s.q. 1.502 Federal Reserve s.q. 1.753 Bank of Norway s.q. 0.509 Reserve Bank of New Zealand

10 Bank of England16 Bank of Brazil17 Bank of Mexico23 Bank of Korea30 Bank of Canada

5 Reserve Bank of Australia13 Federal Reserve14 European Central Bank14 Bank of Japan20 Bank of Brazil21 Bank of England21 Bank of Norway21 Bank of Mexico21 Swiss National Bank27 Reserve Bank of New Zealand

EMPTY

January

February

March

April

May

June

Date Central banks Decision Rate

3 Reserve Bank of Australia3 Bank of Sweden

11 Bank of Korea11 Bank of Canada26 European Central Bank30 Bank of Japan

1 Bank of Brazil1 Federal Reserve2 Bank of England2 Bank of Mexico7 Reserve Bank of Australia8 Reserve Bank of New Zealand

16 Bank of Norway30 Bank of Korea

4 Reserve Bank of Australia5 Bank of Canada6 Bank of Sweden

13 European Central Bank13 Bank of England18 Bank of Japan19 Bank of Brazil20 Bank of Norway20 Swiss National Bank26 Reserve Bank of New Zealand26 Federal Reserve

2 Reserve Bank of Australia4 Bank of Mexico

17 Bank of Korea24 Bank of Sweden24 Bank of Canada25 European Central Bank25 Bank of Norway30 Bank of Japan31 Bank of Brazil

5 Reserve Bank of Australia7 Reserve Bank of New Zealand8 Bank of England8 Federal Reserve

15 Bank of Mexico29 Bank of Korea

3 Reserve Bank of Australia5 Bank of Canada

12 Bank of Brazil13 European Central Bank13 Bank of Norway13 Swiss National Bank19 Bank of Japan19 Federal Reserve20 Bank of England20 Bank of Sweden20 Bank of Mexico

July

August

September

October

November

December