Interest rates on bonds all over the world are plummeting; key rates from several major central banks have already smashed through the 0% barrier, entering negative territory. As investors scramble to find purchase in the global low-yield environment, a commentary from Brandywine Global tries to analyze how the bond market got here.
Viewing the problem through the lens of the US, Senior Vice President of Investment Research J. Patrick Bradley begins by looking at the long-term downtrend in interest rates. He notes that the US central bank has historically aimed interest rate policy at reducing inflation to 2%, a stance that was initiated by a desire to escape stagflation in the 1980s. “Historically, the relationship between inflation and long-term interest rates has held up reasonably well over time. However, more recently there appears to be a divergence as rates continued to slide even as headline consumer prices inched higher.”
He goes on to posit that low yields could be a result of capital pressure applied from countries with savings gluts. Citing a blog post from Ben Bernanke in which he discusses the connection between excess savings and current account surpluses in emerging countries, Mr. Bradley notes that current account surpluses have appeared in other areas, most notably in the eurozone, where Germany has a current account surplus of over 8%. “Exported capital from countries with a savings glut or surplus like Germany could be pushing yields lower,” he suggests.
Finally, he refers to a more recent analysis from Bernanke suggesting that low yields are the by-product of a falling term premium. “In a simple sense, the term premium is merely the extra compensation an investor requires for accepting the additional uncertainties or risks of investing in a longer-dated security,” Mr. Bradley explains. “[T]he negative risk premium suggests risk aversion. Investors are apparently not worried about future inflation, or the future direction of interest rates.” He also allows for the interpretation that investors are willing to pay for the “security” of relatively risk-free bonds, like US treasuries.
Having traced the path leading to the shaky present, Mr. Bradley goes on to suppose that the future could be better. “A better economic climate could presently be unfolding in the U.S. Improving growth and inflation expectations, as well as Federal Reserve policy expectations, would tend to put upward pressure on interest rates… the future direction of interest rates likely could be higher from current levels.”
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