Bond yields ‘set to fall further still’

Global bond yields are to fall further from their current lows over the following nine to 12 months and will stay at this level for next two to three years. This is the view of Schroders’ head of global fixed income Bob Michele.

Currently at 4%, he estimates US treasury 10-year yields will drop to as low as 3%, while in Europe he says 30-year yields will fall from their current level of 3.75% to 3%. In Britain, meanwhile, Michele forecasts that 10 and 30-year yields will both fall to 3.25% from their present yield of 4.25%.

Michele says that until the 20-year channel of bond declines is broken, the bull market for bonds will continue, meaning a positive environment for fixed interest investors.

He says: “Despite the immense liquidity pumped into these economies by the central banks, global growth only ever got as high as 3.5%. This is because most of the liquidity found its way into excessive household borrowing. As a result, to deflate these levels of consumer spending, the central banks are now taking this liquidity back via interest rate rises.”

Another factor driving down yields, argues Michele, is the fact that company pension schemes are being forced to allocate more of their assets to bonds. He says since most of these pensions are underfunded, companies will have to contribute more, which will be paid out of their revenues and earnings.

“As companies don’t want to take the risk of investing this money into the stockmarket, they will allocate more into bonds, which will have the effect of forcing down yields. This trend will continue for the next five years.”

However, while declining yields mean higher prices for bonds, Michele says managers still have their work cut out to generate decent returns, as the starting yield is lower. As a result he hails the introduction of Ucits III regulations as he says it widens his ability to generate capital returns on top of the coupon.

“Before the introduction of Ucits III, bond managers could only use derivatives for hedging risk, whereas today we can use them as part of our active investment strategy to make money. It has opened up more of a two-way investment in bonds as it allows us to take long and short positions in corporate bond issuers and bond markets.”