February 23, 2018
For the past several years the market’s mantra regarding developed market interest rates has been “lower for longer.” That idea was based on the idea that global growth would remain muted, as would wages, and that while deflationary forces had dissipated, inflation was still quite subdued. However, in recent quarters, global growth has shifted into a higher gear. Output gaps have closed in the United States, the eurozone and Japan. We've seen a moderate improvement in wage growth, and, at least in the US, inflation has begun to tick higher.
Add to that backdrop a shift in central bank policies that should see the cumulative impact of quantitative easing begin to reverse later this year. The US Federal Reserve has continued to shrink its balance sheet, the European Central Bank is winding down its asset purchases and the Bank of Japan is buying fewer bonds to maintain its Japanese government bond yield target.
In this environment, it is reasonable to assume that yields on 10-year US Treasury notes could continue to rise. If they rise much further — from around 2.90% today, as of 15 February — observers will question whether the more-than-three-decade bull market in bonds is over. And if it is, investors may assume that a bear market has begun.
In my view, fears of dramatically higher rates are overdone. History has shown that several bond bull markets have ended more with a whimper than a bang. The shift from a falling rate regime to a sharply rising one is not a given. There have been periods in US history when 10-year bond yields have moved sideways for extended periods of time, sometimes for decades. We saw this from the early 1880s until the outbreak of World War I. Additional long periods of stability were seen from the early 1940s through the early 1950s and again during the early to mid-1960s.
Even if yields were to rise considerably from present levels — if, for instance, 10-year yields were to rise to 3.5% or 4% — we would still be in a low-yield regime, in my view. And when this business cycle eventually comes to an end, I think there is a good chance we will extend the pattern in yields that has been in place since the early 1980s: As Exhibit 1 indicates, each successive rate regime has a lower high and a lower low. My belief is based on the US’ deteriorating demographic profile as the population ages, the drag from increasing public and private debt and the disruptive impact to the labor markets of advances in digitization. It is not all that hard to envision US 10-year yields falling below the post–global financial crisis lows near 1.35% when the US economy inevitably enters the next recession and then again struggles to reach escape velocity.
The views expressed in this commentary are those of Erik Weisman and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any other MFS investment product.
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