Ask any bond trader in Tokyo, London or New York what their view on the global economy is, and you’re likely to get a similar, decidedly downbeat answer.
That’s not just because fixed-income types are a dour bunch at the best of times. A quick scan across government debt markets suggests that investors are pricing in the likelihood that growth and inflation around the world will remain tepid for years to come.
In Europe, bonds yielding less than zero have ballooned to $1.9 trillion, with the average yield on an index of euro-area sovereign notes due within five years turning negative for the first time. Worldwide, the bond market’s outlook for inflation is now close to levels last seen during the global recession. And even in the U.S., the bright spot in the global economy, 10- year Treasury yields are pinned near 2 percent-- well below what most on Wall Street expected by now.
“Where are the animal spirits to turn us around?” said Charles Diebel, the London-based head of rates at Aviva Investors, which oversees about $377 billion. What you see in the bond market is “a lack of confidence in the future.”
Diebel says his firm favors sovereign bonds issued by countries that are loosening monetary policy and betting against debt from nations that produce commodities.
Deflation Risk
With the risk of deflation lingering in Europe, China slashing interest rates to combat flagging growth and a raft of indicators fueling concern the U.S. economy is losing steam, it’s not hard to understand why many investors are pessimistic. And the persistent demand for the safety of government bonds also raises thorny questions about whether the Federal Reserve should be raising interest rates when central banks in Europe, Asia and many emerging markets are struggling to revive their own economies.
Appetite for safe assets is so strong in Europe that about 30 percent of the $6.3 trillion of sovereign bonds in the euro area have negative yields, index data compiled by Bloomberg show. That means buyers who hold to maturity are willing to accept small losses in return for the promise that most of their money will be returned.
In the past week alone, yields on about $500 billion of the bonds fell below zero, pushing the average yield for the region’s bonds due within five years to minus 0.025 percent, the lowest on record, data compiled by Bloomberg show.
More QE?
A big part of the push has to do with stubbornly persistent concerns over the state of affairs in Europe. For the 19 nations that share the euro, consumer prices were flat in October after falling 0.1 percent in September. In Germany, the region’s biggest economy, exports in August tumbled by the most since the 2009 recession, while factory orders and industrial production unexpectedly declined.
Among bond investors, that’s bolstered the view the European Central Bank will need to step up its quantitative easing to stimulate demand.
“Even after successive rounds of QE there is no sign of inflation anywhere out there,” said David Tan, the London-based global head of rates at JPMorgan Asset Management, which oversees more than $1.7 trillion. “We still face massive growth headwinds” and that will support demand for even low-yielding bonds.
Worries that lackluster growth will linger aren’t limited to Europe. Bond traders have pushed down 10-year yields in China to 3 percent for the first time since 2009 as the central bank cut rates six times in less than a year to spur what’s poised to be the weakest growth in a quarter century.
New Normal
In the U.S., yields on benchmark Treasuries were 2.13 percent in Asian trading on Monday, less than where they were at the start of the year and well below the 3 percent threshold that forecasters in a Bloomberg survey in January called for by year-end.
Bond investors have snapped up U.S. government debt as reports from new home sales to consumer prices have disappointed. Americans themselves have also pared pared back inflation expectations over the next 5 to 10 years to an all- time low, according to a University of Michigan survey released last week.
The economy is “looking relatively subpar,” said Thomas Tucci, the head of Treasury trading at CIBC World Markets Corp. in New York. “Japan, China, Europe are not growing at the levels they used to. You have to ask, where is the engine?”
Last month, the International Monetary Fund cut its global growth forecasts for 2015 and 2016 as weak commodity prices drive a slowdown in emerging markets. The IMF now forecasts growth of 3.1 percent this year. In the half decade before the financial crisis, annual growth was at least 4 percent a year.
The world’s richest nations also remain threatened by deflationary pressures, according to the Washington-based organization.
Japanese Lessons
Bond traders agree. In the developed world, they see inflation averaging 1.01 percent in future years, based on index data compiled by Bank of America Corp. Rarely has that measure fallen lower since the last recession ended.
Against that backdrop, a growing chorus of voices say the Fed may be moving too soon, especially after policy makers signaled they would consider tightening at their next meeting in December. Based on futures trading, the likelihood of the Fed raising rates by year-end is 50 percent. The central bank has held borrowing costs near zero since 2008.
Among those advising patience are Mizuho Asset Management’s Yusuke Ito, who says the Fed risks repeating the Bank of Japan’s mistakes by trying to head off inflation when it doesn’t exist. Policy makers there, who have struggled with deflationary pressures for two decades, raised interest rates in 2006 and 2007, only to reverse course in 2008.
“Growth is not strong enough to generate inflation,” said Ito, a Tokyo-based senior money manager at Mizuho, which oversees $41 billion. If the Fed lifts rates, “it’s going to stall growth.”
-- Bloomberg
