Historical Stock Chart
6 Months : From Apr 2019 to Oct 2019
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)
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