Bond yields to stay low longer
Bond yields are low but we expect them to remain subdued. Interest rates, inflation, debt levels and changes in monetary policy all point to a long period of low yields on bonds issued by governments and companies. Japan’s experience shows us what that means.
Many of the assumptions behind mainstream thinking have been found wanting, largely because they were guided by central banks that are consistently optimistic in forecasting inflation and growth.
But inflation expectations have consistently failed to come through. Central banks are increasingly cutting their rates close to or below zero. Two of the G3 currencies – the yen and euro – have negative policy rates leaving USD14 billion of bonds experiencing ‘life below zero’ and this could increase, dragging all bond yields still lower.
Reduced use of cash and quantitative easing’s failure to reverse disinflation mean central banks are preparing to go even further below zero. QE is now a regular policy tool but it has been badly misunderstood: it never added to inflation expectations despite earlier claims. The best that can be said is that it buys time, the worst, that its side-effects could be counter-productive.
Meanwhile, debt levels remain excessively high. Global deleverage never happened at the aggregate level. But increasing debt without higher growth requires a lower rate of interest for it to be sustainable.
Policymakers are now increasingly recognising that monetary measures and fiscal stimulus – tax cuts or public spending – are intertwined. Fiscal policy consequences come from monetary actions, so they are complements.
Japan’s experience over the last 30 years underpins our analysis. It has struggled with high debt levels, extremely low inflation, and now has negative interest rates. For bonds, Japanification means permanently low yields for both the short and long term.
It has meant lower yields in other countries as trillions of dollars flow to places that offer better returns. Forecasts for a US recession – or even a full-blown Japan-scenario – would point to lower yields.
Informed by the powerful Japan experience we have cut our bond-yield forecasts from already low levels to 1.5 per cent for 10-year US Treasuries and -0.8 per cent for German bunds through until the end of 2020.
Our 2025 view is that the central tendency for US bond yields is about 2.0 per cent, reflecting longer-term real rates close to zero and inflation continuing to average no more than 2.0 per cent.
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The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Steven Major, CFA
Important disclosures
Fixed income: Basis for financial analysis
This report is designed for, and should only be utilised by, institutional investors. Furthermore, HSBC believes an investor's decision to make an investment should depend on individual circumstances such as the investor's existing holdings and other considerations.
HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has three principal aims in its fixed income research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies in corporate credit and based on country-specific ideas or themes that may affect the performance of these bonds in the case of covered bonds, in both cases on a six-month time horizon; 2) to identify trade ideas on a time horizon of up to three months, relating to specific instruments and segments of the yield curve, which are predominantly derived from relative value considerations or driven by events and which may differ from our long-term credit opinion on an issuer. Buy or Sell refer to a trade call to buy or sell that given instrument; 3) to express views on the likely future performance of sectors, benchmark indices or markets in our fixed income strategy products.
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Definitions for fundamental credit and covered bond recommendations from 22 April 2016
Overweight: For corporate credit, the issuer’s fundamental credit profile is expected to improve over the next six months. For covered bonds, the bonds issued in this country are expected to outperform those of the other countries in our coverage over the next six months.
Neutral: For corporate credit, the issuer’s fundamental credit profile is expected to remain stable over the next six months. For covered bonds, the bonds issued in this country are expected to perform in line with those of the other countries in our coverage over the next six months.
Underweight: For corporate credit, the issuer’s fundamental credit profile is expected to deteriorate over the next six months.
For covered bonds, the bonds issued in this country are expected to underperform those of other countries in our coverage over the next six months.
Prior to this date, fundamental recommendations for corporate credit were applied on the following basis:
Overweight: The credits of the issuer were expected to outperform those of other issuers in the sector over the next six months.
Neutral: The credits of the issuer were expected to perform in line with those of other issuers in the sector over the next six months.
Underweight: The credits of the issuer were expected to underperform those of other issuers in the sector over the next six months.
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All Covered issuers Issuers to whom HSBC has provided Investment Banking in the past 12 months
Count Percentage Count Percentage
Overweight 128 24 78 61
Neutral 270 50 130 48
Underweight 138 26 56 41
Source: HSBC
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