Miami Office
150 SE 2nd Avenue, Suite 704
Miami, FL 33131
United States

Coming Volatility in the Bond Kingdom

  • Posted by: ASG Capital

You can find this Article on Fund Society Website.

Certain distinguished voices are predicting the advent of significant volatility to come on American Interest Rates and erratic bond markets, within the next 12 months.

Following two possible outcomes, their observations are as follows. In the first scenario, the US economy slows down. This will force US monetary policy makers to cut short term rates. In addition, this reduced activity would imply less fiscal revenues and ballooning deficits, in turn driving up long term US rates.

In the second scenario, the US economy continues to do well. This could push US Central Bankers to consider increasing short term rates. This policy choice would lead to rising longer term interest rates as a consequence.

In both cases, American interest rate changes would translate into increasing volatility in the US bond markets. This observation misses one fundamental element: the current interest rates in the rest of the world.

The US has the status of being an economic locomotive for the world. The famous quote “when America sneezes, the world catches a cold” still remains pertinent today. Any US economic slowdown could lead to even weaker activity in other parts of the world such as Europe and Japan.

In an effort to sustain a modicum of economic growth, the policies of the Central Banks for these foreign regions could become even more accommodative. Their local Bond returns would then be so unattractive encouraging capital flows to immigrate to the American shores in search of positive yield returns.

In the case of the second scenario, rising US interest rates would make US Dollar Fixed Income returns more attractive than they are today. Local structural, political and demographic issues are unlikely to make European and Japanese Central Bankers change course from their current policy stance. Here to, one could envision further capital flows moving to the US, thereby mitigating the impact of any interest change to its bond market.

Up and coming erratic volatility in the American Fixed Income market is not at all certain. Foreign money flows moving from other parts of the world to the US could counter balance the negative impact of a change in its monetary policy while acting as a stabilizing investment force for its bond market.

What have European and Japanese investors left to lose? Negative to zero interest rates? Poor local economic activity? Over abundant and unproductive liquidity largely provided from their own local Central Banks? With positive yield returns, the US Fixed Income market remains the ‘cleanest dirty shirt in town’ for bond investors.

Column by Steven Groslin, Executive Board Member and Portfolio Manager at ASG Capital

Author: ASG Capital