HSBC’s Steven Major is out with a bold new forecast.
In a client note on Thursday titled “Yanking down the yields”, the interest rates strategist projected that bond yields will be much lower than the markets expect because central banks including the Federal Reserve are reluctant to raise interest rates.
Major sees the benchmark US 10-year yield, which is currently at 2.05%, averaging 2.10% in the fourth quarter, but then tumbling to 1.5% by the third quarter of 2016. He also lowered projections for European bond yields.
According to Bloomberg, the median strategist’s forecast is for the 10-year yield to rally to 2.9% by Q3 2016 and 3.0% by Q4 2016. Of 65 published forecasts, Major’s 1.5% call is the only one below 1.65%
“Much of the shift lower in our yield forecasts derives from the view that the ECB [European Central Bank] will continue to buy bonds in its QE [Quantitative Easing] program. The forecast for a ‘bowing-in’ of curves reflects our opinion that a long period of unconventional policy will create an unconventional outcome. Central banks did not forecast the persistently weak growth or recent decline in inflation. So data dependency does not easily justify lifting rates from the zero-bound — it might suggest the opposite.”
In September, the Federal Reserve passed on its first interest rate hike in nine years, as the labour market still needed some further improvement, and concerns about global weakness weighed on members’ minds. Also last month, European Central Bank president Mario Draghi said that the ECB would expand its stimulus program if needed.
For years, pros across Wall Street have argued that interest rates have nowhere to go but up. Major was one of the few forecasters to correctly forecast that in 2014, bond yields would fall and end the year lower. Others had predicted that yields would rise as the Fed wound down its massive bond buying program known as quantitative easing.
“The conventional view has been that a normalization of monetary policy would be led by the Federal Reserve, involve a rise in short rates and a flatter curve,” Major wrote. “This has already been proven completely wrong.”
Once again, Major is going against the grain to say that yields will fall even further, although the Fed has maintained that it could raise short-term interest rates this year.
He is in the small minority, with others including Komal Sri-Kumar, president of Sri-Kumar Global Strategies, who wrote on Business Insider earlier this week that the 10-year yield would slide below 2% to 1.5%.
Also, DoubleLine Capital’s Jeff Gundlach forecast in June that bond yields will end 2015 near where they started the year. Gundlach also noted in his presentation that yields have risen in previous periods when the Fed raised rates.
The 10-year yield was at 2.17% at the beginning of January. On Thursday, it was near 2.05%.
Typically, higher interest rates make existing bonds less attractive to buyers, since they can get new notes at loftier yields. And as demand for these bonds fall, their prices also fall, and yields rise.
This chart shows Major’s forecasts versus the consensus:
And here’s a chart of the 10-year yield going back 50 years.