This question has been asked since 2009, and despite the unwavering unanimity of economists and market watchers that sovereign bond yields are once again set to rise—the latest Wall Street Journal survey, for example, shows 100% of economists expect the US ten-year yield to rise by the end of 2014 (average forecast: 3.04%), June 2015 (3.40%), and December 2014 (3.72%)—we expect rates across the developed world to remain low for quite some time, due both to continued central bank activities and the reliance of current “growth” areas on low yields.
Behold the Power of the Printing Press
To begin with, developed world central banks remain “all in” in their commitment to keeping rates low, encapsulated by European Central Bank President Mario Draghi’s 2012 pledge to do “whatever it takes” to hold the Eurozone together. Such sentiments have been echoed by Federal Reserve Chair Janet Yellen—who takes every opportunity, most recently at an IMF speech in July, to tell investors policy rates will stay very low for an extended period—and Bank of Japan Governor Haruhiko Kuroda, who has implemented a quantitative easing program roughly three times the size of the Fed’s on a GDP-adjusted basis.
The reasons for this are widely known but perhaps not fully appreciated. While central bankers often talk tough on inflation, they clearly view deflation as the greater evil—understandable given the events of 2008, and the realities of our overleveraged world—and will thus “go to the mattresses” to prevent it.
Some point out that central banks only control the front end of the curve, but this is disingenuous for several reasons. First, by shrinking the supply of high-quality collateral (e.g., buying most short-end government bond issuance), central banks force investors to buy longer-dated paper; this has been exacerbated by new regulations that “encourage” pensions and insurance funds to hold sovereign bonds for solvency requirements, and banks to hold short-term paper to meet more stringent capital and liquidity requirements.
Further, most investors underestimate the ability of central banks to continue buying bonds. To put this in sharp relief: as issuers of a given currency, central banks can purchase unlimited quantities of bonds priced in that currency—or other assets, for that matter—with electronic currency created (in the words of former Fed Chair Ben Bernanke) “at essentially no cost.” It is true such actions, taken to their logical extreme, would cause severe damage to the currency’s value—although we seem nowhere near this point at present—but investors can safely ignore warnings about central banks’ leverage ratios, or the possibility of their “going broke.”
In short, central banks have not only the will, but also the means, to hold down interest rates across the curve for an extended period of time.
It’s the Economy, Stupid
The other impediment to rising yields is the fact that what “growth” there is in the global economy (most notably in the United States and the United Kingdom) seems highly dependent on low yields. Consider what the US and UK housing markets would look like with mortgage rates even 100 bps above current levels, or the US auto market without widely available 72-month, no interest (subprime) financing. Or the overall economy with equity markets significantly below current levels. This of course ties in with the above argument—central banks are clearly aware of this, and thus committed to keeping rates low—and is a variant of the old saw about commodities that “the cure for high prices is … high prices.” In this case, were rates to somehow tick up despite central bankers’ best efforts, they would bring about their own demise by destroying the few existing vestiges of economic growth.
The Pain Trade
Finally, the pervasive and persistent unanimity among investors and economists that rates will rise should give any true contrarian pause; indeed, we are somewhat nonplussed that more observers have not thought it worthwhile to question their assumptions given how long they have been wrong. (We count ourselves in this category, as we mistakenly expected quantitative easing to cause a burst of inflation due to a misunderstanding of what central banks were actually doing. That is beyond the scope of this piece, but suffice it to say while central banks are indeed “printing money,” their ability to get it into the economy remains, at least for the moment, significantly constrained.)
Eric Winig is a Managing Director on the Cambridge Associates Global Investment Research team.