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March 2019 saw 10-year bonds dipping into negative yield territory. The difference between German sovereign short-term rates (2 years) and the long-term ones (10 years) now stands at 0.50%, half the level of a year ago. A similar move can also be seen in US government debt over the same period.
Several factors lie behind these recent rate changes. Central bank monetary accommodation continues in certain parts of the world, notably in Europe and in Asia. In addition, there is a growing anticipation of slowing world economic activity which would indicate that future global interest rates are likely to remain low. With longer dated European government debt now at around 0%, these bonds join the already significant stock of Japanese sovereign instruments currently showing similar levels of yield.
European and Japanese bond returns are dwindling. As a consequence, more of the world’s savings pool could migrate towards US Dollar (USD) denominated debt assets in search of the positive yield these instruments still provide. If these capital flows were to rise significantly in the coming months, the effect would be to drive down US interest rates from their present levels.
In sum, both short- and long-term yields in Europe and Japan are converging towards 0%, while at the same time the differential in interest returns between large economic blocs is being reduced. In this kind of environment, US Dollar bond investors will have to seek out yield where they can find it.
This generalized ‘world hunt’ for yield could lead to a tightening of spreads between private sector debt and US government bonds. Subordinated dollar instruments (especially those of large systemic issuers) stand to benefit very favorably from this up and coming trend.
Column by Steven Groslin, Executive Board Member and Portfolio Manager at ASG Capital