Degroof Petercam: How persistent is the low rates anomaly?

25 years ago, the reference 10 year Bund stood at 8.30% and 10 year US Treasuries at 7.50%. Bond investing has been very rewarding over such a long period. Between 1995 and today European Government Bonds returned 5.55% annually. Peter De Coenselzoom, CIO Fixed Income, zoom in on this prosperous period for fixed income.

Looking back over the past 116 years we can make the assessment that at the end of 1981 with 10 year US rates at a 15.15 % high and German rates at a 9.85% high we witnessed an aberration or anomaly. Over this extended period US 10 year rates traded between 1.5% and 4.5% two thirds of the time i.e. during 75 out of the 118 yearly observations.

Different constellation

In retrospect it was comparable with equity valuation at the turn of the millennium just before an aggressive bear market ensued. Back in 1981 it was a long term bond bull market that took off. At the end of 2016 the constellation could not be more different with 10 year rates at -12bp in Germany, -10bp in Japan and – 57bp in Switzerland we are in the midst of a second aberration or anomaly.

The questions we raise:

1. How persistent is this low rates anomaly?
2. Is unconstrained bond investing part of the solution?
3. How has the Universalis Unconstrained fund coped over the years?
4. What is our current portfolio construction telling you?

The first point will be addressed by comparing past with future monetary policy conduct.Points 2 to 4 will be answered alongside four parameters that influence bond valuations and portfolio construction:Liquidity conditions

• Regulatory influence
• Volatility conditions
• Fixed income opportunity set

How persistent is the low rates anomaly?

The persistency is related to the level of commitment to conduct optimal and transparent monetary policies by G7 central banks. As soon as we passed the Great Financial Crisis (GFC) bond markets have been leading central banks in the assessment that an excessively indebted developed world would be deflationary on behalf of productivity, prices and potential growth rates. This has correctly been expressed by a continuous fall in rates, at times exacerbated or interrupted by the quality of implementation of QE programs.

Over the past year central banks have departed step by step from the belief that the unique steady-state narrative that aspires to reset towards macro-economic averages of the past: pushing output growth above trend, forcing unemployment rates towards historic levels, communicating on willingness to push inflation at or slightly above 2%. This narrative is summarized through the infamous Fed dot plots that have been continuously far above the policy rates expected by market participants. The above thinking on monetary policy is outdated.

The narrative becomes fixated on regimes. Monetary policy will be optimized against the background of a certain regime. The current regime we go through in developed markets is one of:

• low productivity growth
• low real rate regime
• low recession probability or prudent but steady business cycle

It is up to the financial market participant to assess the risks of a regime shift. Within the US, as long as we do not see inflation surprises (due to wage pressure), an increase in recession probabilities or upward pressure on real rates we will be stuck with accommodative or dovish FED monetary policy. The US Treasury yield curve will experience very little volatility with short, medium and long term rates anchored around current levels for long. The BoJ’s decision to control not only the short end but the long end of yield curves as well points in the same direction. This will impact international capital flows and will reinforce the above condition.

If we would observe a rise in US recession probabilities the US Treasury curve will bull flatten and steer 10 and 30 year US Treasury rates even lower than the current 1.60% and 2.30% levels.

Yield curves for the EU and Japan draw a somehow different picture. The aggressiveness of QE programs and negative interest rate policies have put these curves for 80% to 90% in negative territory. That releases stress onto EU banking and insurance businesses.

The BoJ and the ECB need to focus more on the health of the financial industry at large as they represent the credit channel par excellence in these regions. As such, the ECB should stop implementing the current QE program based on capital key, GDP weights of countries within the Eurozone. The ECB should adopt a higher degree of flexibility and prevent scarcity issues. That would propel faster convergence across EMU yield curves and go hand in hand with upside normalisation of the Bund reference curve. Under stable monetary policy conditions (deposit rate at -40bp, Refi at 0%) 10 year bunds would slowly grind towards a healthier 25bp to 50bp range over three years.

Die komplette Marktanalyse als pdf-Dokument.

Die Präsentation Bond management in a low rates environment.

Die Präsentation The Bonds Universalis Unconstrained.

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