No matter where you look, sovereign bond yields have fallen to all-time record lows.
From Europe to the US, Japan to Australia, yields have been plummeting, seeing records set not only every day, but every hour on some occasions.
It’s been relentless, and remarkable, as explained by Martin Whetton, interest rate strategist at ANZ.
“The most recent quarter has delivered some extraordinary outcomes in interest rate markets. While negative yielding interest rates have been a feature of markets in the last year, the percentage of bonds trading with yields of less than 0% has increased sharply,” he notes.
“A recent report from ratings agency Fitch shows USD11.5 trillion of sovereign debt is now in this category.”
As a result of the continued decline in yields, it has seen global sovereign bond yields in developed nations collapse to the lowest level on record.
The chart below, supplied by ANZ, tells the story perfectly. “Look out below”!
The question many are now asking themselves is what does it all mean? Is it simply due to central bank asset purchases, conducted as part of quantitative easing, that’s been responsible for the remarkable decline, or something far more concerning.
To Whetton, it’s the latter.
“The recent softening of data, particularly in the US has challenged a more optimistic view of the world and puts in doubt the path to higher policy rates this year,” he says.
“The recent falls in yield should not be characterised as value buying, particularly in jurisdictions where yields are negative. The moves, while accentuated by QE programs and liability driven investments, are the result of fear.”
Fear. Fear of where global growth, and as a consequence inflation, is heading.
As Whetton points out, while central bank policy is contributing to the decline in yields, the signal that interest rate curves is sending to businesses and households is anything but pleasant. It also paints a different picture to the confidence being expressed by stock markets.
And he believes that the decline in yields will likely continue in the period ahead.
“We have revised our yield forecasts lower for global bond markets, with an expectation that benchmark US 10- year Treasury yields will trade at 1.25% in coming months,” says Whetton.
As a consequence, he believes this has the potential to push investors into longer-dated and riskier investments, creating additional concerns.
“Low yields are forcing investors out the duration curve and down the credit rating curve which presents threats such as the recent locking of commercial property funds in the UK,” says Whetton.
While the environment forces investors into these trades, we are wary that the backdrop of decelerating growth and credit concerns will mean the potential returns will experience volatility. This is most obvious in credit markets.
Although sovereign bond markets have largely being driven by fear of late, Whetton suggests there are also risks if these fears suddenly dissipate.
“However, the duration trade, or buying long maturity securities can also be a volatile one,” he says. “Any uptick in growth or inflation expectations will be most strongly manifested in a sell-off this sector of the market. This will give investors pause for thought over such investments.”
As a consequence, Whetton expects “volatility to remain elevated for longer given the uncertain backdrop in the political and economic world.”
In other words, the recent increase in volatility is likely to become the norm rather than the exception.
You can follow Martin on Twitter. His handle is @martin_whetton