group predicts further rises in govt bond yields but does not foresee a fixed interest collapse
Legal & General Investment Management (LGIM) predicts further rises in government bond yields, but does not think a wholesale collapse in fixed interest is on the way.
The group is factoring in a fair yield for long-dated US Treasuries of 5.25%-6%, against 4.75%-5.25% for equivalent duration gilts and 4%-4.5% for Bunds. As such, it expects German government bonds to be the best performers, followed by the UK and then the US.
Andrew Clare, chief economist at LGIM, said there is still substantial excess productive capacity in the US and developed economies. As such, he suggested economic recovery is not going to be as strong as in previous cycles, and so government bond yields are unlikely to rise to LGIM's fair value targets in the near term.
'Although we believe yields will tend to rise from here, they are not likely to return to these higher fair values as rapidly as they may have done in past recoveries. This is because this will not be a normal recovery. There is still substantial excess productive capacity in the US economy and elsewhere in the developed economies of the world,' Clare said.
There have been strong moves in government bond yields in the past few months which have prompted fears that yields would rise and prices fall.
The redemption yield on 10-year gilts fell to 3.88% on 16 June, the lowest level in more than 50 years. At the same time, 10-year Treasury bond yields fell to an intra-day low of 3.07%. Shortly after, bond yields started to rise sharply.
Clare said the steep falls in global government bond yields were driven by investor concerns in the US that the economy would suffer deflation.
The reason behind the collapse, according to LGIM, is that until this point bond markets had faith in low interest rate policy and had effectively given Alan Greenspan the benefit of the doubt. 'However, by June, with the Fed Funds Rate at 1.25%, Greenspan seemed to have run out of bullets at a time when the economic data seemed to be suggesting that more bullets were necessary,' Clare added.
At that stage, Greenspan was hinting that he would consider using unconventional monetary policy measures to stimulate the economy once rates had been cut as far as possible. The measure that seemed the most likely was the purchase by the Fed of long-dated Treasury bonds.
As far as Treasury investors were concerned, Clare said, the Fed was hinting strongly that it would act as a buyer of last resort, thereby making it safer to buy these bonds, even at very low yields, because if prices fall they could always sell them back to the Fed.
He added: 'The idea that the Fed would step in to buy Treasuries, coupled with the weak economic data at the time, was enough to push Treasury and government bond prices around the world to historic highs.'
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