This year’s flood of monetary easing is slowing to a trickle as the world’s central banks judge they’ve done enough to avoid a recession, giving investors cause to think sovereign bond yields have finally bottomed.
Federal Reserve Chairman Jerome Powell last week said policy had reached an “appropriate” level after three cuts in interest rates this year. Mounting criticism of the European Central Bank’s negative rates leaves its new president, Christine Lagarde, under pressure to hold fire on additional stimulus, and Bank of Japan Governor Haruhiko Kuroda may be even closer to the limits of monetary policy.
As economists at Citigroup Inc. declare the arrival of “peak dovishness,” investors are responding by offloading bonds on the assumption there will be less support from aggressive central banks going forward. The 10-year Treasury yield, a benchmark for debt around the globe, has rebounded to nearly two per cent from a three-year low of 1.43 per cent in September, with the rest of the world’s markets following in its wake.
“We are past the peak of central banks easing,” said Peter Schaffrik, a global macro strategist at RBC Capital Markets. “You may get a few more cuts here and there, but the extreme cutting phase is over. And with that, yields in the U.S. and globally are at risk of going higher. I’d be cautious about fixed income now.”
Of the 57 institutions monitored by Bloomberg, more than half cut borrowing costs this year, reaching a crescendo in recent weeks.
Now the tone is changing amid signs that the worst is over for a global economic slowdown and that the U.S. and China may be able to resolve some of their differences over trade policy. Sweden’s Riksbank is even stressing its determination to hike by the end of the year.
Policy-makers also know they can only cut interest rates so far, and in countries where they’ve turned negative there’s a growing backlash from banks and politicians. Many, including Lagarde and Kuroda, are placing the onus on governments to do more to support demand if needed.
“Central banks may be approaching the limit in terms of how much more they can help the economy,” said Pernille Henneberg, an economist at Citigroup. “If financial conditions had reached tight territory, that could have been very damaging to the economy. They have tried to go against all the uncertainty from the trade war, and maybe they have done enough now. Focus is now changing to what fiscal and monetary coordination can do.”
While there’s a shift in momentum, investors will be all too aware that the past decade has seen several false dawns for both central bank rates and yields. This time last year, economists at Goldman Sachs Group Inc. and JPMorgan Chase & Co. were among those predicting the Fed would raise rates four times in 2019. JPMorgan Chief Executive Jamie Dimon famously warned in 2018 that the U.S 10-year yield was headed to four per cent from about three per cent.
And though there are signs the slowdown may be bottoming out, risks remain. It’s not clear whether trade talks between Washington and Beijing will continue toward a comprehensive agreement and the European Union and U.K. have still to resolve Brexit. Inflation also remains well below the target of what many central banks are mandated to deliver.
“Central banks may well have reached the peak of what they’re willing to do right now, but I do not think that will last in 2020,” said Luke Hickmore, a money manager at Aberdeen Standard Investments, who is snapping up bonds across Germany, Australia and Canada. “I am a buyer if yields jump higher.”
There may yet be room for more rate reductions. Economists at Bloomberg Economics are among a handful who say the Fed will do more in coming months, and Switzerland and Australia could also shift. Emerging markets such as Brazil, Mexico, Russia may act too.
But the brunt of the easing is probably over unless the outlook darkens again. For traders, that may be a game-changer after a decade of monetary juice kept a lid on yields and left about US$13 trillion of investment-grade global bonds with rates below zero.
What’s bad news for havens such as government bonds may be good news for other asset classes. U.S. stock benchmarks climbed to all-time highs this week, the Stoxx Europe 600 Index marched to a four-year high and major Asian indexes advanced. U.S. investment-grade debt has also rallied.
“Central banks will mostly stay quiet next year on monetary policy,” said Fabrizio Fiorini, the chief investment officer at UBI Pramerica SGR. “There also won’t be the same level of trade-war struggles. This environment will be one marked by better growth, higher yields — with steeper yield curves — and more stable developed-market share prices.”
Markets are feeling more rosy than just weeks ago. It’s true that money markets point to more easing, rather than tightening, by central banks, but pricing for the next Fed move has pushed out toward 2021. And while 15 basis points of cuts were factored in for the ECB by the end of this year, none are now expected at least through the end of 2020.
“After all the central bank easing, the market is pricing in that they expect growth,” Brian Weinstein, head of global fixed income at Morgan Stanley Investment Management, told Bloomberg TV. And regarding trade wars and political issues, the sense is that “uncertainty has peaked.”