The yield-dampeners: will interest rates inevitably rise when QE ends?

After the ‘taper tantrum’ of 2013, many commentators predict that the catalyst for a sell-off in fixed income assets could be the ending of quantitative easing by the US Federal Reserve later this year. In the latest issue of our Panoramic Outlook series, I present an alternative view to this consensus thinking, analysing a number of dynamics in bond markets that have surprised investors during this period of extraordinary monetary policy. My emphasis is on what I view as three key ‘yield-dampeners’ at work that investors should be aware of:

• The fragility of the global economic recovery and high debt levels in the US economy make it unlikely that interest rates will return to pre-crisis levels, limiting the potential downside to bonds.
• There are some powerful structural deflationary forces which are helping to keep inflation low.
• A strong technical factor – the global savings glut – is likely to remain supportive to fixed income assets as is firm demand from large institutional pension funds and central banks.

Given these influences, it’s very much possible that those looking for yields to rise back to pre-crisis levels when QE ends may be disappointed. Not only are these yield-dampening forces at play in the US Treasury market, but they could also easily be applied to the UK or European government bond markets, potentially providing a useful lesson for the future path of yields. This will impact the attractiveness of other fixed income assets such as investment grade and high yield corporate bonds. Arguably, ultra-low cash rates and a stable interest rate environment for government bonds would provide a solid base for corporate bond markets as investors continue to seek positive real returns on their investments. The full analysis is located here.