Long-term interest rates remain stuck in a range that has defined the last six years. Russ discusses why 2018 may see more of the same.
The English translation of déjà vu is “already seen”. This is probably as good of a description of the U.S. bond market as any. Although short-term interest rates did rise this year as a slightly less timid Federal Reserve (Fed) nudged the policy rate higher, for the long end of the curve it was more of the same. U.S. 10-year yields look to end the year just about where they started, in the middle of a range that has defined the past six years (see the chart below).
10-year government bond yields
Will 2018 be yet another year in which history not only rhymes but really does repeat? Probably.
As I discussed back in early August and November, there are several powerful, long-term factors that are keeping rates contained: low nominal gross domestic product (GDP), itself a function of changing demographics, the disinflationary impact of technology, and even lower yields outside the United States.
Another critical factor, recently highlighted by my colleague Jean Boivin, is a still high global savings rate. While U.S. consumers may be more profligate, precautionary savings rates in Asia have kept global savings high. This is important because, as Jean demonstrated, there is a link between global savings and the U.S. term premium, i.e. the extra rate investors receive for investing in long-term bonds. When savings are high, the term premium is more likely to be low, in the process keeping nominal yields down.
Given that none of these factors are likely to change dramatically in 2018, does this suggest more of the same? Is there any potential to change this dynamic?
Growth and policy
Two things that will look different in 2018: the potential for faster growth and central bank policy. Starting with the former, going into 2018 the global economy has momentum; this trend is likely to be reinforced, albeit temporarily, by U.S. tax cuts. In addition, for the first time since the crisis the Fed’s balance sheet will be shrinking.
That said, to my mind neither a temporary acceleration in growth nor a moderation in central bank policy is enough to materially push long-term rates higher. A less accommodative Fed removes one prop from the bond market, but the reduction in purchases is dwarfed by the likely increase in global savings, i.e. there are plenty of private sector buyers looking to hedge long-term liabilities.
For rates to move materially higher, what is really needed is inflation. Here the evidence is mixed. The Fed’s preferred measure of inflation, core personal consumption expenditures (PCE), is stuck below 1.50%. Many of the big, “stickier” components of inflation, such as medical care and housing, are actually decelerating. In the absence of a sustained increase in core inflation, bond market investors are likely to experience another year of “already seen.”
Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.
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