Bob Baur
Interest rates: near a low in long-bond yields
“The eight-month plunge in 10-year U.S. treasury bond yields is likely over. Yields will slowly work higher into year-end. At some point, rising interest rates will become a problem for stock and credit markets, likely late next year or in 2021.
“For 35 years, yields on 10-year U.S. treasury bonds kept falling, from 15.8% in 1981 to 1.3% in 2016. After that long drop, plus a decade of deflation dread and near-zero interest rates after the financial crisis, it’s no wonder investors are certain inflation and interest rates will stay lower for longer.
“However, no trend lasts forever, even one that lasts for 35 years. It just becomes easier to extrapolate. The world growth slump and tepid inflation are what’s keeping safe-haven, government bond yields at mind-bogglingly low levels. Both may be about to change, for a few reasons:
- First, long-term bond yields will begin to reverse their decline once the expected rebound in world growth becomes evident later this year
- And second, inflation has been weak the last several months as a lagged effect of the world growth slowdown from mid-2018. The most recent data suggests this year’s down pressure on inflation is fading. Tight labour markets and rising wages have been a consistent theme in developed countries.
Looking ahead
“The Fed should still follow through on their implicit pledge to lower the fed funds rate by 0.25% in July and perhaps again in September. That will reverse the yield curve inversion, extend the expansion as Fed Chair Jerome Powell described, and keep the labour market pulling workers off the sidelines.
“Following these cuts, the Fed will surely have a high bar to raising rates again. The next rate hike may not be until inflation has been at or above the Fed’s target for at least a few months, likely well into 2020.”
World economic outlook
- The US: “Happy birthday to the expansion that begins its eleventh year this July, making it the longest in U.S. history. Trade uncertainties aren’t impacting small businesses yet, where expansion plans and optimism are near-record.”
- China: “The restrictions on debt growth that brought the slowdown to China have been removed and funds are flowing. Interest rates and tax rates are lower, required reserves for banks have dropped, and public infrastructure spending has ramped up. Using official data, growth in China will likely hit the government’s 6.0% to 6.5% target range for 2019. Growth may fade in 2020 and beyond as the stimulus wane, the labour force starts to contract, and increasing debt fails to provide much of a further boost to growth.”
By Bob Baur, Chief Global Economist at Principal Global Investors