Despite talk of a ‘great normalisation’ of monetary policy, persistent deflationary pressures mean global interest rates are set to stay lower for longer, according to Ariel Bezalel, manager of the Jupiter Strategic Bond Fund.
Since the beginning of 2015, some observers have ‘called the top’ of the great bond bull market – the call in my view is somewhat premature. Prevailing economic forces suggest instead that the great bond bull market is far from over, and global central bank policy is likely to remain loose for the foreseeable future.
The predictions of rising yields have generally centred around four claims. Firstly, bond bears point to evidence of improving economic conditions in the US and other advanced economies, which are set to break free from the stagnation which followed the financial crisis. Secondly, evidence of intensifying cost pressures via tightening labour markets and early signs of wage inflation, particularly in the US, are likely to force policy makers to raise rates sooner rather than later.
Thirdly, with economic health restored, the US Federal Reserve is set to take the lead in the process of normalising interest rate policy after many years of extraordinary stimulus. Finally, it has been suggested that bonds have simply entered a bubble, and, like all manias, that bubble must eventually burst.
This debate, played out against a backdrop of monetary stimulus in Japan and Europe and worsening conditions in emerging markets, has led to a significant rise in volatility in global bond markets so far of the year, as interest rate expectations have diverged.
This debate was brought into sharp focus as the September Fed meeting approached. Prior to the meeting, we took the view that the Fed was unlikely to raise interest rates in light of the bout of market volatility in August, amid fresh concerns about the health of the global economy.
These global pressures are what caused the Fed, which has been itching to start normalising monetary policy, to stay its hand in September, having already done so in March and June. In our view, the decision to keep rates on hold was the latest signal that attempts by global central banks to slay the spectre of deflation have failed. Since the global financial crisis, central banks have engaged in an unprecedented cycle of monetary easing.
All told, there have been approximately 700 interest rate cuts worldwide since the Fed last hiked rates in 2006 while over $10 trillion worth of asset purchases have taken place. Yet despite the magnitude of these measures, inflation across many of the world’s major economies is hovering close to zero. Globally, nearly 30% of countries are now gripped by deflation. In nearly 60% of countries, inflation is less than 2%.
Consensus forecasts for GDP growth have also been slashed since the start of the year, amid mounting evidence that emerging market economies are slowing at an alarming rate. The collapse in commodity prices so far in 2015 has only exacerbated existing deflationary pressures.
While other observers eager to call the first US rate hike are now citing December as the likely lift-off point, we see no signs that the deflationary forces in the global economy are abating. Far from weakening, we think that many of the fundamental forces driving deflation will persist for years to come. In our view, there are three key forces which will act as headwinds to price rises in the foreseeable future.