The summer of 2019 has seen bond yields in developed economies fall to historically low levels. Interest rates on debt instruments issued by the German government all along the yield curve (from 3-month to 30-year maturities) are now negative.
- Despite the recent rise, yields on US Treasuries remain positive, but close to record lows. What happens next?
- Is this extraordinary development a bubble with risk of a rapid correction?
- Are US Treasury yields also destined to fall through the zero lower bound?
- In this post, Dominick Dealto, our Chief Investment Officer for Fixed Income, gives his views on the outlook for bond markets.
Dominick, do you think there’s a bubble in the bond market?
No. While negative yields are difficult to sustain over the long term, there are few signs of irrational exuberance. Central bank asset purchases have certainly contributed to driving yields lower; central banks represent a stable buyer base and an abrupt end to their purchases looks far from likely.
Will there be a damaging crash?
That is not our near-term base case, but how the market reacts to central bank policy tweaks remains an unknown and could lead to bouts of rising volatility.
Which areas of fixed-income markets present the biggest risks or offer the least value?
Pockets of the below zero investment-grade corporate credit market, particularly in the US, are one example where investors are not adequately compensated for the risks emanating from deteriorating fundamentals and its sensitivity to global growth.
Could the yield on US 10-year Treasuries go negative — what is your forecast?
We expect the pace of economic growth in the US to slow from current levels, so we see potential for lower Treasury yields. However, we do not expect yields to turn negative just yet. Even with significant downside surprises to economic data, the US Federal Reserve is better positioned to jumpstart the economy relative to central banks in the rest of the developed world.
Exhibit 1: Interest rates on most German and Japanese bonds are now negative. Only US Treasuries continue to offer positive yields
Should investors sell, hold or buy fixed-income assets with negative yields?
Hold over the near term, but they should explore a global fixed-income opportunity set that includes sectors such as hard currency emerging market debt and US structured securities that we believe still offer compelling yield potential.
What should central banks do now?
Central banks are likely to loosen monetary policy further in response to the ramifications of trade tensions and slowing global economic data, but with monetary policy already stretched, fiscal stimulus could well be the need of the hour.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.