Amid all the calls for higher inflation and continued growth in the US, Treasury yields have failed to meaningfully rise.
Treasurys have remained attractive, keeping yields low, as investors consider a blurry growth picture in the US combined with uncertainty about geopolitics and President Donald Trump’s economic agenda.
“I think we’re more likely to go to Mars before we have a 4%-5% 10-year Treasury,” David Bianco, chief investment strategist for the Americas at Deutsche Asset Management, said in an interview with Business Insider. “I think it stays near or below 3% through this cycle.” Yields rise when bond prices fall.
“Rates markets sit at an important intersection,” said Matthew Hornbach, a strategist at Morgan Stanley, in a recent note. “The stoplight for reflation has turned green again, but global sovereign markets have not yet shifted into drive,” suggesting that investors are waiting for better economic data and equity-market performance, he added.
The current economic recovery is likely to extend its run and become the longest ever in US history, surpassing the expansion from 1991 to 2001, Bianco said. But during that time, the 10-year yield would struggle to rise well beyond 3%, he added.
Treasurys fell on Thursday, with the 10-year yield up three basis points at 2.36% at 11 a.m. ET. The Federal Reserve on Wednesday said economic weakness in the first quarter was likely transitory, further convincing Wall Street that it will raise interest rates at its June meeting.
“About 2% is about as high as the Fed goes, assuming there’s no inflation problem” that prompts the Fed to combat it by raising rates even higher, Bianco said. The benchmark Fed funds rate is in a range of 0.75% to 1%.
Higher commodity prices could theoretically stoke inflation, but that’s not relevant right now, he said. Crude oil, for example, faces a structural barrier to returning to $US70 or $US80 per barrel because the market is oversupplied.
The labour market is another unlikely source of inflation in Bianco’s view. That’s because incomes may not rise meaningfully enough to cause a wage-price spiral in which higher wages raise demand for spending and consequently, prices.
“I think wage growth will only go up if productivity goes up,” he said. Higher inequality in the US has meant that salaries are increasing at a slower pace than worker productivity, compared to how they tracked each other before the 1970s. But the output growth that employers get out of investing in new workers has been on the decline globally, making stronger wage growth less likely despite a tight labour market.
Lower borrowing costs, which encourage companies to take on debt and buy their own shares, could continue to support the stock market.
“If I’m right that interest rates continue to stay low as the cycle continues and the Fed does a little bit more hiking, and the Fed doesn’t see the need to go above 2% even in 2018 or 2019, I think the S&P’s PE on a forward basis goes from 18 to 20,” Bianco said. “A lot of things that people think are overvalued like utility stocks have more upside.”
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