Pramerica SGR's Patrizia Bussoli on what the yield curve says about growth

Eugenia Jiménez
Pramerica SGR's Patrizia Bussoli on what the yield curve says about growth

Although the gap between short-and long-term yields remains a valid indicator for the growth cycle, it seems that the 10-to two-year gauge may not be best one to look at, the Bank of England said in a blog post recently.

"The yield curve slope appears to have regained some of its predictive power, as policy rate expectations are again positively and significantly associated with future GDP growth while the term premia has stopped obscuring their signal," read the post.

Traditionally, the shape of the US yield curve has been seen as a popular business cycle indicator, and a fall of longer term yields below shorter term yields has historically been considered as a powerful signal of recessions.

But some argue that the distortions created by the era of post-crisis monetary policies have broken the relationship between interest rate expectations and economic growth.

Patrizia Bussoli, who is responsible for heading the team of asset allocation products in the Italian asset management firm Pramerica Sgr, shares with InvestmentEurope her views on the validity of the yield curve as an economic indicator.

Q: Do you feel the generally accepted definition of yield is still valid?

A: The introduction of non-conventional monetary policies during the Crisis has enriched the tools of monetary policy and the way it affects fixed income markets. The role of the balance sheet as a tool of monetary policy means that size and composition of central banks balance sheets will affect yield level (through the size effect) and the shape of the yield curve (through the composition effect). On top of it, the introduction of forward guidance has a role in giving more evidence on the way central banks form their decisions, therefore reducing information asymmetries between central banks and markets.

Q: Does the focus on yield - financial repression - by macro policymakers (central banks) need to be changed?

A: The evolution of monetary policy as just described should lead in general to lower volatility in the government bond markets and to more stable rates at least in time in which growth is floating around potential and inflation hardly picks up. The evolution could be different in times in which growth will be above potential in a sustainable way. If lower volatility on the one hand is deemed to decrease opportunity of returns in fixed income, on the other side, more stable yields offer the possibility to evaluate risky asset class over short and medium period in a different way and have a greater portion of portfolios on these investments with respect to the past. 

Q: Have you been adjusting the way you view yield in regards to other factors when determining what fixed income assets to consider?

A: Yields and yield curve analysis have changed through time. In particular, the role of the different premiums embedded in yields, from the term premium to inflation risk and growth risk premium. The new monetary policy has made real yields more and more relevant in evaluating fixed income assets.

Q: Does debate on what the ‘correct' yield on, say, government debt, should be make you think about the relative performance of other asset classes, such as equities, differently?

A: As said before, the evolution of monetary policies makes the fair valuation of yields different and in some cases (like in the eurozone) more complex with respect to the past. Lower yields and lower rates volatility for longer implies an adjustment as well in the evaluation of risky assets, of equities in particular. Market structure of equity volatility is therefore impacted. This makes the transmission between financial markets and real economy stronger, and more sensitive.