“Do what you can, with what you have, where you are. “
You can’t ask for a better indicator of what’s happening across the world in the yield space than the recent issue of a new bond in Europe by H & M Group of EUR 500m / 8.5-year / 0.25% coupon bonds. This bond was heavily oversubscribed despite the very low coupon, demonstrating just how desperate investors are for positive yielding instruments.
On the flip side, yields in the US 30 Year Govt bond have been rising strongly over the past couple of months. Fed Chairman Jerome Powell was asked about this recent upward move in yields but did not show any real concern, indicating that the move so far reflects higher growth expectations. He expects growth to pick up in the second half as vaccinations increase, the US gets the virus under control and the economy continues to reopen. He did seem to push back a bit on expectations for inflation, mentioning a few times that while he expects upward pressure on prices as the economy reopens, he is not expecting “large or persistent inflation increases”. He added that he does not expect a “burst” of fiscal or monetary policy to drive a big change in inflation and that “inflation risks are to the downside” So all in all he was a bit more upbeat on growth and less concerned on a jump in inflation.
On the home front and in line with the above commentary Westpac have upgraded its US 10-year forecast from 1.5% to 1.8% by end 2021. By the same token the expected rate by the end of 2022 has also been lifted from 1.75% to 2.4%. Interestingly the focus has now started to shift to inflation adjusted or real yields. We have now reached the point in both Australia and the US where the break-even inflation rates (meaning inflation and interest rates are matched and not negative anymore) are nearing central bank targets of 2% (on average) for the US and 2–3% for the RBA. The inference being that central banks are now focusing on real inflation rates and the impact of these on those depending on interest income to live.
Another indicator that things have started turning around is the data release in Australia this week showing employment had risen a healthy 29,000 in January and subsequently the unemployment rate had fallen from 6.6% to 6.4%. The strength of the labour market and confidence notwithstanding, the RBA remains committed to their extraordinary stimulus for the foreseeable future.
The bottom line and certainly no surprise, is that central banks around the world remain committed to providing as much stimulus as needed to support the global economy and at the same time keeping rates as low as possible. Given the level of gross national debt across the world, any upward move in rates could be hugely detrimental to the health of Government accounts. This further strengthens the argument that bond investors will continue to chase yield at almost any cost.