By Daniel Kruger
At the beginning of the year, most economists and investors
believed that bond yields were poised to finally climb out of their
postcrisis funk. One exception: HSBC Holdings PLC's Steven Major.
His contention that longer-term structural issues would suppress
yields has made him one of the most-bullish analysts in the U.S.
Treasury market.
It is a stance validated recently as a surge in demand for
government debt drove the 10-year yield -- which helps set
borrowing costs throughout the economy -- below 2% for the first
time since 2016. Among investors' immediate concerns were signs of
slowing growth and expectations the Federal Reserve will cut
interest rates. But Mr. Major sees other factors at play as
well.
The 54-year-old started as a bond analyst in 1989, with the long
bull market in government debt already well under way, and joined
HSBC in 2001, rising to global head of fixed-income research. He is
also an avid runner and a "long-suffering, third-generation" fan of
the Premier League's West Ham United. He spoke to The Wall Street
Journal about the Treasury market, what it may signal about the
economy and what he anticipates from the Fed.
Q: What is your long-term view about the Treasury bond
market?
Our forecast for the U.S. 10-year Treasury yield at the end of
2019 is 2.1%. I recognize that yield might go lower than our
forecast, but we've spent most of the last few years with a
forecast below where the market is in general, and [also below]
where most people have been expecting. For me, "lower-for-longer"
is no longer a forecast, it's an observation. The state of the
world today is such that rates cannot go up, they have to come
down.
Q: What do you look at that informs your thinking?
The Fed has been consistently revising down its own longer-term
projection of where the policy rate will settle. That's accessible
to everyone through the Fed's dot plot. The longer-term dot is a
measure of where the Fed collectively, on aggregate, thinks it's
going to go. That level today is 2.5%, and six years ago it was
4.25%. To me that's one of the most important guides to where bond
yields can be.
The reason the long-term dot has been falling is there are
longer-term drivers bearing down on the policy rate, limiting how
far it can rise. These include global factors like the level of
debt, demographics, and distribution of wealth, disruptive
technologies, all these kinds of things. And the Fed has been
recognizing these longer-term developments in their own
projections. The single most important factor in our forecasts is
debt. We believe the increase in global debt levels, across private
and public sectors, lowers future growth through the debt-servicing
channel.
When we make the forecast for the bond yields, we try to look
through the noise of the incoming cyclical data. If you're asking
me what makes us different than everybody else, we're looking at
the longer-term drivers and we are controlling for some of the
noisier stuff, like the payrolls data, the monthly purchasing
managers data and projections for the current-year GDP [gross
domestic product].
Q: What makes employment data less significant to your overall
outlook?
You could ask the question, "Why does everyone else look at it?"
The Fed has revised downwards its own projections for where the
unemployment rate would be. It was only as recently as 2014, five
years ago, that they projected a threshold of 6% unemployment at
which they would have to tighten policy. We're now well below that.
There's also just how inaccurate the data is. That's why you have
such huge revisions each month.
We have questions regarding the assumptions underlying the
Phillips curve. The idea that unemployment, at a certain level,
will drive wages -- and therefore inflation higher -- has many
assumptions that don't seem to be correct. It seems to us that the
Phillips curve is global, and we are looking at markets
globally.
Q: Do you think it was geopolitical risk that led the Fed to
change its thinking?
The Fed became a bit more practical and a bit more realistic
last October, I think, on the basis of international data.
And at the time it looked to us like the incoming economic data
from the eurozone and China together with the U.K. and a few other
parts of the world was much weaker than had been expected. The U.S.
economy was still growing... so I think the local forecasters in
the U.S. were taking a U.S.-centric view and therefore may not have
seen a more complete picture.
Q: This rally is quite a turnaround from the high yields we saw
then. Does that suggest to you that the economy is on the verge of
a similar turnaround?
This looks like one of those occasions where the yield curve
inversion at the front end is signaling a potential recession. The
point is, whether or not you forecast a recession doesn't really
matter. You just have to forecast lower growth than was previously
expected, and therefore the Fed changing its outlook and policy
rates to try and put a floor under the growth level. We should note
that a good portion of the rally is pricing out the over-optimism
bias from previous expectations. In other words, previous
expectations of rate hikes beyond 3.0% had to be reversed before
expectations of rate cuts could be priced in.
Q: What are investors' biggest concerns that have supported
rising demand for the safety of government bonds?
What's happened here is quite interesting because in the last 12
months there's been more than $1 trillion of additional buying by
U.S. domestic investors. And this has gone through a period of time
when people were discussing whether foreigners would tolerate
bigger fiscal deficits. In fact, the domestic investors have voted
with their feet. They've had no problem buying liquid high-quality
securities. Not only are these safe government bonds, they're safe
government bonds with yield.
Q: Central banks are trying to revive inflation expectations.
How important is that task?
Based on the last six years there have been systematic downside
inflation surprises more often than not, if we look across all
measures of inflation. Based on the last 20 years there has been a
more symmetrical outcome. Over the last six years or so there's
been a consistent undershoot. This is part of the story for the
bond market rally.
Q: Throughout this period of low inflation, the Fed has often
referred to it as transitory. Is the Fed wrong or missing the
larger picture?
After a series of downsides that are being explained by
idiosyncratic risk, it stops becoming idiosyncratic and becomes
systemic. And to me that's sort of where we are.
You might say that our bond-yield forecast should be lower today
than it is. As I've said, we've had it low for a while. Maybe it's
going to go lower -- I don't know. But the reality is we've got six
months of the year to go.
Write to Daniel Kruger at Daniel.Kruger@wsj.com
(END) Dow Jones Newswires
June 28, 2019 12:14 ET (16:14 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.
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