The global yield picture still favors the U.S.
Yields of German 10-year bunds and Japanese government bonds (JGBs) are almost exactly where they were last spring, the latter being a function of central bank policy. With yields of 40 bps and 5 bps respectively, neither bunds nor JGBs offer much competition to the U.S. 10-year note. Of the world’s large, liquid sovereign bond markets, only Australia is currently offering higher yields.
Those still expecting a second-half rise in rates could rightly point to the pending reduction in the Federal Reserve’s (Fed’s) balance sheet. To be sure, to the extent quantitative easing reduced rates, logic dictates that its removal should lift them. The question is by how much.
Nobody has lived through a Fed balance sheet reduction, leaving its impact unclear. What is becoming obvious is that few feel a need to rush to the exits. Despite a well telegraphed campaign from the Fed, 10-year nominal rates, real rates and the term premium (a measure of compensation for taking on additional duration risk) remain at or below where they were in May.
Meanwhile, the various longer-term forces that have been constraining rates remain very much in place: an aging population, persistent institutional demand for long-dated assets and the disinflationary impact of technology. Moreover, it is worth observing that the slippage in yields has occurred against a backdrop of a strong bull market, one characterized by almost zen-like tranquility. Hedges have not been much in demand. Which leaves the question: What happens to bond prices and rates should investors ever want to start hedging again?
Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.
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