Jeremy Lawson
Standard Life Investments, the global investment manager, has investigated the unprecedented factors keeping US bond yields so low. In the latest edition of Global Horizons, “A Brave New World for Bond Markets”, Jeremy Lawson and Sebastian Mackay look at whether bond markets are pricing in a great stagnation and how yields are likely to evolve through the rest of the business cycle.
Jeremy Lawson, Chief Economist, Standard Life Investments said: “These are highly unusual times in the world of fixed income. The factors weighing on bond yields are numerous, complex and in some cases, unprecedented. In this paper we take a deep dive into what determined the shifts, and identify the structural and cyclical drivers restraining bond yields. Our analysis has uncovered a number of important economic and policy drivers of this low US and global interest rate environment.
“Aftershocks of the financial crisis are still being felt, seven years after Lehman Brothers collapsed. Our analysis shows that the scarring from the crisis and prolonged private sector deleveraging has raised desired savings, weighing on domestic demand and inflation. Weakness in domestic demand in advanced economies has been amplified by policy mistakes and this has depressed labour markets, discouraged firms from investing, and held down inflation. Productivity growth, which had been in decline even before the crisis, has weakened further, underpinned by the drought in private and public capital spending.
“Both by accident and design, central banks and regulators have been pursuing policies that lower real interest rates and term premia, enhancing the demand for all income yielding assets. Central banks have been forced to keep short term interest rates at or even below the zero lower bound, and to put in place unconventional policy measures aimed at suppressing real interest rates along the entire yield curve.”
Jeremy Lawson continues: “Looking ahead and taking account of these special factors – why should the market change its mind and begin to anticipate higher long term interest rates? We examine the potential triggers for long-term bond yields to shift in the US. If recoveries in the advanced economies become more self-sustaining and if emerging market economic and financial conditions do not deteriorate further, inflation expectations could pick up. The Fed should be willing to accommodate some increase in real interest rates. Investors might also demand more compensation for holding long-term interest rate risk.
“We conclude that it is unlikely that the long term interest rates will return to their pre-crisis norms. Our research suggests that the benchmark US 10 year government bond yield will peak at 3 to 4% during the current business cycle. This would be above today’s levels but well below the peak of previous business cycles.”