Global interest rates are close to their recent lows, despite our view that growth risks are fading. In addition, it appears likely that the Federal Reserve will extend its pause longer than the market anticipates, and there is a chance of a pivot to a new policy framework (as discussed in our blog: Five things we think could go right for global markets in 2019). Both factors argue for higher bond yields and steeper yield curves going forward.
The eurozone economy expanded by only 0.2% in the fourth quarter of 2018, about half its potential growth rate.1 A large part of the unexpected deterioration was likely the result of weak domestic demand and business investment. We believe economic sentiment will soon benefit from the unwinding of adverse temporary factors, but we expect the European Central Bank to maintain its dovish rhetoric in an attempt to restrain spreads and reduce market volatility. With markets not pricing a first interest rate hike until well into 2020, the bar for more dovish repricing seems high.
We remain neutral on Chinese interest rates due to our continued expectation of supportive Chinese monetary and fiscal policies, potential investor shifts toward credit and US Treasury yield movements. We believe China’s monetary policy will remain accommodative and fiscal easing will play a more active role going forward. In the medium term, liquidity will likely remain reasonably accommodative, but investors may cut interest rate positions and add risk via the credit market due to the recently announced series of credit-supportive measures. US Treasury and Chinese equity market performance could impact the performance of Chinese onshore interest rates.
Japanese government bond yields fell in February, with 10-year yields hitting a year-to-date low of -0.04%.2 We believe the catalyst was a combination of weaker domestic and international economic data and more dovish rhetoric from the Bank of Japan and other central banks. The yield curve has become increasingly directional as short-term yields have approached the -0.2% floor, resulting in a sharp flattening move.3
Ongoing Brexit uncertainty and weaker global growth (especially in the eurozone) have resulted in sharp downward revisions to Bank of England growth forecasts. The urgency to hike interest rates has lessened, even in a relatively positive Brexit scenario. This reduces the upside for yields, in our view. In the short term, UK gilts will likely be impacted by quantitative easing reinvestment flows in March, which may further constrain the upside for yields. However, a more positive Brexit outcome could lead to a modest bounce in yields, especially if European growth shows more signs of recovering.
Economic growth softened in the fourth quarter of 2018, prompting the Bank of Canada (BOC) to deviate, at least temporarily, from its path of normalizing rates. Employment remains strong, offsetting some softness in the housing market and retail sales, but market expectations for the next BOC rate hike have been pushed into 2020. Given that other major central banks have shifted to a more dovish stance, we believe the BOC will be cautious before hiking rates again. At 1.92%, the 10-year Canadian government bond yield remains near its lowest levels of the past year and does not appear attractive, in our view.4 We do not see any immediate catalysts to push yields higher.
Reserve Bank of Australia (RBA) Governor Philip Lowe confirmed that the central bank’s policy bias is now symmetric and not toward higher rates as a next move. Although the RBA cut its growth and inflation forecasts in February, they remain above consensus expectations. This raises the risk that the RBA could cut rates even in response to a relatively small downside data surprise, especially if it stems from labor market deterioration. This outlook somewhat validates current market pricing of a 25-basis point interest rate cut by the end of 2019.
Lower than expected January inflation and a surprise interest rate cut by the Reserve Bank of India (RBI) in February have further extended the interest rate rally that began in October 2018. We still find current yields attractive from a valuation perspective and see room for long-term rates to decline further in the near term, especially on 10-year government bonds. We expect several supportive factors to remain in place through the first half of 2019, including low inflation, RBI liquidity improvement measures and another possible interest rate cut at its April policy meeting.
1 Source: Eurostat, data from Feb. 14, 2019.
2 Source: Bloomberg L.P., data from Jan. 1, 2019 to Feb. 25, 2019.
3 Source: Bank of Japan, data from July 31, 2018.
4 Source: Bloomberg L.P., data from Feb. 21, 2019.
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UK gilts are bonds issued by the British government.
Dovish refers to an economic outlook which generally supports low interest rates as a means of encouraging growth within the economy.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.