Western bond yields may not rise as quickly after QE as most expect and they could be on a path to ”Japanisation”.
M&G Investments investment director Anthony Doyle says there is a strong consensus that yields can only rise, but several factors could mean it never happens.
Many believe the trigger for a bond market sell off could be the end of US QE, which at the current rate of tapering would be in October, he adds.
However, several dynamics have surprised fixed income investors during the years of extraordinary developed world monetary policy and there is a chance they could do so again, he argues.
The fragility of the global recovery and the amount of debt in the US economy mean rates will not return to pre-crisis levels, which mitigates potential downside risk.
Enduring demand from pension funds and banks are also likely to help keep bond prices from falling considerably. As will the global “savings glut”, he says.
The Federal Reserve’s bond buying programme is not the only thing impacting US Treasury yields, he says.
US interest rates are likely to remain low for a long time, especially with the absence of inflation, he says.
“The US economy cannot work off the excess leverage that has built up over a period of 30 years unless interest rates remain low.
Also, Federal Reserve economists have calculated the natural rate of interest –the risk-free rate that would prevail if output is at its potential – is -0.4 per cent.
“Apart from a couple of brief periods over the past 15 years, the [US] real interest rate has been below the natural rate of interest, indicating an expansionary setting of monetary policy,” Doyle says.
Another “yield dampener” is the weak economic data that has come from the US since February. The recent bout of disinflation has helped push bond prices higher as less inflation premium is factored into the yield, he adds.
“Another strong tailwind for fixed income markets is blowing due to the fact that both equities and fixed income assets have had such a great run over the past couple of years,” he says.
“Both public and private pension plans are now better funded and are increasingly looking to lock in their gains before volatility begins to pick up again.”
Finally, western government bonds could be heading down a path of “Japanisation”, he adds.
“For investors, one trade that has always lost money, over any reasonable time period, has been the shorting of Japanese government bonds. This trade, unique in its consistency, developed its own name: ‘the widow maker’.”
For the past 24 years, Japanese sovereign debt yields have fallen from 8 per cent highs to just 0.64 per cent today. Despite Abenomics, the stubbornly low yields – and the widow maker trade – remains, he says.
“History might not repeat itself but it does rhyme. US, German and UK government bonds yields are following an eerily similar path to Japanese government bonds in the early 90s.
“The question has to be asked: Is shorting developed market government bonds the new widow-maker trade?”
Source: M&G Investments, Bloomberg