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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Disclosure and disclaimer

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