Long-term bond yields reflect growth doubts
While many global sharemarkets have surged higher this year, yields on longer-term bonds remain well below their December highs, signalling fixed-income investors are more circumspect on long-term economic growth and inflationary expectations than could be deduced from equity markets.
Bond yields move inversely to prices, meaning they fall when demand for the safe harbour asset is high. The decline in longer-term yields since December suggests some doubts over the long-term economic outlook.
“In the last quarter of 2016, we had a vast shock,” said Jamieson Coote Bonds’ executive director Charlie Jamieson. “Not just in Trump’s election necessarily but in Republican clean sweep of Washington. It wasn’t expected by the market. It created a decent pullback on bonds in expectation of much higher US domestic growth, and much higher additional inflation.
“After a move of that magnitude – bond yields don’t continue to move with that kind of voracity.”
This may be due to a continuing lack of detail about the shape of US economic policy.
“We don’t have any details about Trump’s plans,” Mr Jamieson said. “We know there’s a plan to have a plan. But haven’t seen detail or funding implications of how things will be paid for. That makes it difficult to have concrete moves of any additional magnitude.”
In , the government easily sold $11 billion of 10-year notes last month – the third time in six months a new record bond offering has been set. Both two-year and 10-year government bond yields trended lower in the first six weeks of 2017 before edging up over the past few weeks as markets brace for US rate rises. But at 1.84 per cent and 2.81 per cent respectively they still remain well below their December peaks. n bond yields remain well above their US peers, but the spread has narrowed in recent months as global investors price in more monetary tightening by the Federal Reserve.
The outlier in the bond picture is the yield on two-year US government bonds. This spiked to an eight-year high at the end of February, to above 1.3 per cent or even higher than the sharp rise in December. The gap between short and long-term yields suggests investors are more bullish on short-term than long-term US growth.
“Expectation of rate hikes, [which occur] late in economic cycle, is bad for long dated bonds,” Mr Jamieson said. The last Federal Reserve rate-hiking cycle was between 2004 and 2006, and during this period the yield on 10-year US government bonds fell almost 99 basis points, from 4.9 per cent to 3.8 per cent in mid-2005, with yield peaking just before the first rate hike in 2004.
Perhaps something of this effect can be seen in the soaring of bond yields late last year. Markets are pricing in three US interest rate hikes in 2017, after sabre-rattling from a number of US Federal Reserve officials.
Long-term bond yields have been falling consistently since the 1980s, a dynamic that has left some viewing the December 2016 spike as something of a correction. Bell Potter research analyst Damien Williamson said the sharp yield rises seen in late 2016 could be attributed to a normalisation of 10-year government bonds from all-time record low yields set in the September 2016 quarter. Despite recent falls, bond yields remain elevated from 2016 levels.