The global expansion remains intact, but with considerable regional variation. Strong labour markets and overly high inflation still require tighter-for-longer monetary policies and are keeping short yields, in particular, elevated. While the expansion supports equities, the key question in the short term is whether long yields can go even higher? These are some of the key themes in our new AM Quarterly View report.
At Danske Bank Asset Management, we currently assess the long end yields to be significantly above the fair long-term level in the US. Bo Christensen, Head of Macro & TAA at Danske Bank Asset Management.
Rise in long US yields wrong-footed us
As Q3 2023 kicked off, we were expecting further modest increases in equity prices and relatively stable bond yields. Hence, the rise in long US yields, in particular, wrong-footed us, and was our most important forecasting error over the summer.
Therefore, the question now is whether long end bond yields have in fact stabilised. If not, equities are likely to slide again in the short term, as markets are currently very sensitive to the uncertainty surrounding the discounting of future value, and especially the earnings of growth-oriented businesses.
We therefore note that uncertainty has increased in the short term but nevertheless maintain our expectation that the global expansion will lend support to equities. Meanwhile, slightly lower growth in the US combined with significant risk premiums at the long end of the US yield curve should reduce the chances of further strong rises in mid- to long end bond yields.
Good stories, but difficult to quantify
Our key focus centres on long end bond yields. At Danske Bank Asset Management, we currently assess the long end yields to be significantly above the fair long-term level in the US.
Explanations abound, of course, and some quickly become difficult to quantify and ‘voodoo’-like. These arguments stretch from a lack of purchases (or even direct sales of bonds) by the central banks and China’s reduced purchases of government bonds to supply and demand analyses and rising potential growth driven by technological advances (think artificial intelligence).
Common to most of these explanations is that they are good and obvious stories, but often difficult to quantify.
Decent value in the medium-to-long end US yields
Calling them ‘voodoo’-like is not reflective of a desire to neglect them. They all play an important role. Indeed, we have adjusted our own expectations for the US equilibrium short rate (spot r*) from around 2.5% in the spring to around 2.9% now. The driving forces have been ongoing new research that points in that direction as well as the most recent positive revision to longer term realised US growth and the fact that the economy has proved surprisingly resilient to the tightening of monetary policy.
However, interest rates are significantly higher right now, which therefore leaves risk premiums (e.g. term premiums) as the focus point. We have also adjusted our fair estimates slightly higher here – in part due to the continuing deterioration of US government finances and steadily rising debt-to-GDP ratio. But even including the total effect of the adjustments mentioned, we are nowhere near quantifying a 30-year yield of 4.7% as approximately fair. Rather, our fair estimate is around 3.6%, which is why we continue to argue there is decent value in the medium-to-long end of the US yield curve in particular.
READ MORE in our new AM Quarterly View here.
This material has been prepared for information purposes only and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.
