Longer-term lower constraint on US bond yields is on hold by its view towards 2022

For years, many had hoped that the 10-year US Treasury yield would return to 2%, the psychologically important level seen as representative of a healthy US economy.

It hasn’t happened yet. And while consensus forecasts currently call for that to happen in 2022, a handful of analysts are warning the opposite: that widely watched yields will generally continue to slide lower, as it has been in the last three or four decades. .

Impactful 10-year yield
TMUBMUSD10Y,
1.583%,
This affects everything from car loans to mortgages, credit cards and student loans, which have not been at 2% since August 2019. It repeatedly went into shortfalls. compared to that, even as the US is at the end of its longest economic expansion on record, and yields now hover around 1.60% despite the highest inflation in nearly 31 years. And investors see few, if any, meaningful catalysts to propel it higher sustainably by year-end.

Dimitri Delis by Piper Sandler Cos.
PIPR,
+ 1.37%

in Chicago and Richard McGuire of Rabobank, a Dutch conglomerate, are among the few analysts who have dared to stay lower for longer on yields. They say they sometimes worry about whether or not they should go out on their own, but they keep their point of view by focusing on trends that span decades and a the big picture of what is driving continued demand for US government bonds.

“I just keep an eye on the data and won’t deviate from it regardless of whether it’s wrong or right,” said Delis, a nuclear physicist by training and senior macroeconomic strategist and econometrician at Piper Sandler. . He said that fifty-year’s worth of 10-year yield data shows it dwindling with each passing decade, while fluctuating in the range of about 70 basis points annually in either direction, although at times. when there is a temporary catalyst that pushes it up.

“Every time there is a catalyst for higher yields, that catalyst fades away,” Delis said by phone. “Why? Because yields naturally want to go down.” However, he said, “sometimes I look at consensus and think, I don’t want to be the only one stuck out there.”

Delis and Rabobank’s McGuire said factors driving 10-year yields lower include continued demand from foreign buyers and US corporations, a lack of positive-yielding options from other countries. and the possibility that the current hot US inflation will give way to weaker economic growth. and the tendency to disinfect when all the dust settles. In McGuire’s view, much of the Fed’s pandemic stimulus is being channeled into financial assets like bonds rather than the economy, contributing to lower yields.

Aging demographics, globalization and automation are just some of the deflationary forces that existed before the COVID-19 pandemic hit, and they are not yet gone, Delis and McGuire said. Their forecast for 2022 includes the possibility that the 10-year rate could drop to 1%, a level last seen in January before the US economy fully reopened. Strategists also see a significant risk of yields falling to zero over time, considering other mature bond markets have had – a view made in 2019 by JPMorgan’s Jan Loeys Chase & Co.
JPM,
-0.85%.

The longer yield is the same as the 10-year yield
TMUBMUSD10Y,
1.583%

and 30 years
TMUBMUSD30Y,
1.970%

often taken as an indicator of investor sentiment about the economic outlook, although some say their signaling power has been distorted by the Fed’s pandemic-era bond-buying program.

As yields fall, investors are said to be buying Treasuries, presumably because of their safe-haven appeal, and the economic outlook is seen as negative. And vice versa: as yields rise, investors will sell off government bonds amid greater confidence and perhaps move into riskier assets, like stocks. Recently, however, stocks and bonds have sometimes moved together, with investors pouring into both asset classes or withdrawing from them at the same time, because financial markets are supposed to be the day. become increasingly detached from economic fundamentals.

For years, bigger names in financial markets like billionaire bond investor Bill Gross have overshadowed the voices of a few opposition in the lower camp in the long run. Gross has say many times that he thinks the bond bull market is over, meaning an end to the rampant buying of Bonds that has kept yields lower for decades. Bank of America Michael Hartnett and economists Jeremy Siegel is among those who have expressed similar views since last year.

Meanwhile, bond market bulls such as Delis, McGuire and HSBC’s Steven Major, the Hong Kong-based global head of fixed-income research, was generally right about the drop in Treasury yields, albeit skewed on the exact extent. Late last year, Major’s team was reported to have called for a continue to protest in the Treasury in 2021 and see 10-year yields in the 0.75% range for a few years. More recently, he said that yields on 10-year Treasuries should “Uber-hawkish” changed by the Fed to go back to 2%.

The long-term lower’s view is particularly notable as the Federal Reserve is in the process of finding exceptional support for the economy and is widely expected to begin raising policy rates. next year to combat higher inflation. The easing of bond purchases and the prospect of rate hikes are often cited as catalysts that can drive yields up.

While interest rates on short-term debt have edged higher since September in anticipation of tighter Fed policy, long-term yields have barely risen much, costing even the most discerning investors a loss. alert. Some hedge funds There has been significant damage from false bets on rate direction this year, according to the report, after positioning for yield differentials to widen, rather than narrow.

Delis and McGuire say they were also wrong to envision the impact that U.S. political outcomes could have on the bond market.

For example, Delis said he doesn’t think Donald Trump can be the catalyst for higher interest rates, but 10 years after Trump’s surprise 2016 presidential election victory over Hillary Rodham Clinton. Treasuries soar the most in three years.

Last December, Delis projected 10-year yields could average 1.1% for the year and range between 0.5% and 1.7%, but only the latter will come to fruition. realistic.

Meanwhile, also late last year, McGuire said that he predicts a 10-year period of a decline of about 1% by the end of 2021. That was before. Democrats take control of the United States Senate in January, leading to a significant spike in yields in the following months.

“The further the market strays from your forecast, the greater the risk that you have completely misunderstood something,” said McGuire, head of rate strategy at Rabobank and a graduate of Oxford University’s Merton College. greater. “That leads to a lot of soul searching, but as always, we’re very reluctant to hop on a chariot unless we can prove why we’re doing it.”

Before becoming a strategist, McGuire ran a language school in Slovakia in the early 1990s, after the fall of the Berlin Wall. He said he watched as the post-socialist economy was rebuilt into a capitalist one, an experience that gave him “a worldview not based on descriptions in textbook”.

McGuire said by phone from London: “What is happening now is that many people are refusing to give up on textbook approaches, and we think that structural forces have only intensified during the pandemic.

Earlier this year, it looked like President Joe Biden was $1.9 trillion American rescue plan would be enough to kickstart the economy and possibly bring the 10-year rate back to 2%, from a year low of 0.9% on Jan. 4, but yields haven’t risen above near 1, 8% of March for the whole year. .

Meanwhile, forecasters continued to revise their expectations higher throughout the first half of the year, ending June with the consensus estimate for the 10-year yield ending 2021 at 1.9%. Instead, interest rates fell to as low as 1.1% in August and have largely stayed in a tight band below 1.63% for months, despite hot inflation indicators and the 3rd day decision. November by the Fed to gradually withdraw monetary stimulus.

Theoretically, there is still a chance that the 10-year rate will increase 40 basis points to 2% in the six-week period before the year ends, as a similar-sized jump has been seen since October. February through March, but the Federal Reserve has only had one policy meeting over, in December, and is beginning to ease its bond purchases.

Meanwhile, two more potential catalysts – persistent US inflation and an earlier-than-expected Fed rate hike next year – were accounted for by traders. One final catalyst, the impending announcement of President Joe Biden’s pick to chair the Federal Reserve, has been buzzing the markets for weeks.

The coronavirus pandemic has created distortions and supply-side shocks, making it harder for traders and analysts to interpret the data. Unlike many traders and analysts who focus on signs of persistent inflation, McGuire sees evidence that the pandemic “has weakened the bargaining power of labor,” as demonstrated by the Wage growth slowed in sectors such as transportation and warehousing.

“And if wages don’t respond sufficiently to price pressures, consumers will feel poorer,” says McGuire. “So inflation now is inflation later, and if we look around, all the upsides to inflation this year could be reversed.”

Before becoming a strategist, McGuire ran a language school in Slovakia in the early 1990s, after the fall of the Berlin Wall. He said he watched as the post-socialist economy was rebuilt into a capitalist one, an experience that gave him “a worldview not based on descriptions in textbook”.