Looking further out, will yields ever rise? (Yes, but not by much.)

GLC 2020 Mid-Year Capital Market Outlook:

There’s a longer-term risk that bond yields will rise. Yields may experience upward pressure driven by ballooning government deficits (as revenues decline) and from spending on unprecedented fiscal stimulus and entitlements. However, deflationary forces (low commodity prices and dampened economic activity) will offset the inflationary forces for the duration of our forecast horizon into 2021. 

Furthermore, a variety of central banks, most notably the U.S. Federal Reserve (Fed), are openly discussing that a yield curve control (YCC) strategy could be implemented to restrain longer-term bond yields should markets begin to balk at inflation or ballooning government deficits. This strategy was pursued by the Fed during and post-WWII1 and has been pursued with reasonable success by the Bank of Japan since late 2016 (and remains ongoing). The Reserve Bank of Australia has recently committed to YCC due to the COVID crisis. 

Aside from these factors that could restrain bond yields, the level of debt around the world itself is likely to restrain sovereign yields to being lower for longer (for… ever?). The debt-laden global economy simply cannot withstand yields rising by much. The burden would crush growth and promptly send  yields retreating. However, this comes at a cost; we don’t view consequence-free debt as a ‘free pass’ for governments to borrow infinitely (as some might suggest is possible). The implication of low bond yields cascades across other asset classes, and society as a whole. Beyond the pain for savers and pensions, low bond yields dampen rates of return across other asset classes over the longer term - witness Japanese bond and equity returns3. They also potentially curb animal spirits and the ‘creative destruction’ so necessary to innovation, entrepreneurship and progress. If fiscal and monetary expansion support unproductive consumption, and capital flows prop up ‘zombie’2 companies or industries, it has the potential to distort valuable market price signals that can result in the misallocation of capital, and therefore slower future growth. 

1 The U.S. Federal Reserve, in conjunction with the Treasury department in 1942, fixed the U.S. yield curve in an upward-trending fashion, with the front end anchored at 0.375% and long end at 2.5%. Yield curve control continued until February 1951, when the last of the pegs was removed. 

2 ‘Zombie’ companies: firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing – a group that has grown from <5% of U.S. corporations pre-2009 to over 18% today. Source: Datastream, Worldscope, DB Global Research via Axios. 

3 The Tokyo Nikkei 225 Equity Index total return, local currency from 1991-2019 is 1.2%; and since its 1998 inception, the S&P Japan Bond Index (includes governments and corporates) has delivered a 1.6% local currency annualized rate of return. 

GLC 2020 Mid-Year Capital Market Outlook:

Copyright 2020 GLC. You may not reproduce, distribute, or otherwise use any of this article without the prior written consent of GLC Asset Management Group Ltd. (GLC).

This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.