The drop in yields accelerated on Friday following the disappointing US labour market report. Not only was the September number roughly 50,000 below expectations, but the August payroll numbers were revised lower as well. In addition, hourly earnings were flat and the labor participation rate fell to its worst level since 1977. Lowered economic growth expectations are also putting pressure on high yield bonds. Last week, investors removed $1.5bn from the asset class, the largest weekly outflow since July 1.
Going forward: Back to old tricks
Friday’s sudden turnaround in stocks could be interpreted as foreshadowing yet another shift in the investment regime: a renewed reliance on central banks. Not only did US investors treat a weak jobs report as a sign the Federal Reserve (Fed) will hold off on raising interest rates (giving bonds an excuse to rally), but other countries are following suit.
European equities stand to benefit from a weak inflation print, which may prompt further quantitative easing by the European Central Bank. A similar pattern is evident in emerging markets such as India, where last week stocks benefited from an unexpected rate cut from its central bank.
We still don’t believe a US recession is on the horizon, but it is becoming clear that the US is not immune to the global slowdown. Second-half growth is likely to be considerably slower than the nearly 4% we witnessed in the second quarter. The more pessimistic outlook for the economy, which is pushing back expectations for a Fed hike, is also driving short-term yields down. Last week, two-year Treasury yields fell as low as 0.55%, roughly 10 basis points below where they started the year.
Investors may be feeling a bit of “déjà vu all over again,” to quote the recently departed Yogi Berra. As we have seen in recent years, in a world where the Fed keeps rates anchored at zero, stocks benefit, if only because they compare favorably to cash and negligible bond yields. This is an environment in which some old themes, such as income-producing equities, come back into vogue as investors gird for an even longer spell of “low for long” rates.