30 September 2021
Rates on the move
With US and UK government bond yields jumping higher, we take a look at the drivers and where yields could go from here.
The key driver of the recent move higher in government bond yields has been central bank rhetoric. In the US, the Federal Reserve (Fed) provided markets with much needed clarity on its tapering timeline. The September Federal Open Markets Committee (FOMC) meeting pointed towards a formal taper announcement at the November meeting, with the programme ending in mid-2022. With regards to interest rates, the dot plot is now showing a half-hike in 2022, three hikes in 2023 and another three in 2024, although two of the members that were likely in favour of hiking rates in 2022 have retired since the meeting. The higher dots were driven by higher inflation forecasts as Fed Chair Jerome Powell stated that the “substantial further progress” threshold, from an inflation perspective, has been achieved. While the labour market mandate has not yet been met, the labour market has recovered more than 75% of the jobs lost during the depths of the pandemic and Powell remained optimistic on the potential for jobs growth. The Bank of England (BoE) also opened the door for a rate hike this year, indicating that hiking is possible before the end of quantitative easing (QE) due to growth optimism, a stronger labour market and inflation expectations.
Government bond yields have taken another leg up over the past week with the 10-year benchmark yield rising 0.22% to 1.54% in the US and 0.19% to 0.99% in the UK. These are the largest one-week moves since February, which is significant. In terms of where we think rates will go from here, we expect the US 10-year yield to trade in a range of 1.5% to 2.0% over the next six months, creeping higher, albeit not at the same pace as we have just witnessed, as above-trend growth and accommodative policy start to fade. Longer term, the Fed’s forecasted terminal rate remains unchanged at 2.5%. In the UK, we believe that 10-year government bond yields will reach 1.25% in six months’ time. (Data as of 28 September 2021).
US and UK 10-year government bond yields have risen sharply over the last week
Investor positioning has been a key technical factor in the recent rate move. While investors generally still have a short duration bias in their portfolios, according to positioning surveys, they have started to become a little less short. With the Fed and the BoE clearing the way for tapering, they will be buying fewer government bonds going forward which is a significant demand tailwind that will be reduced and thus yields should find it easier to move higher. The knock-on impact of higher yields across the rest of fixed income is that investors who have been hunting for yield may be more willing to buy the likes of investment grade bonds which now look a bit more appealing.
What does this mean for fixed income investors?
The recent sharp move higher in government bond yields was triggered by the acknowledgement from central banks that their inflation mandates are on solid ground, given more persistent inflation in some parts of the economy, as opposed to the transitory nature that was initially touted. Therefore, tapering of asset purchases is likely to commence when the market expected, but the speed of tapering will likely be faster than initially anticipated. With this news now digested, we believe that rates will continue to climb higher, but at a more gradual pace so long as there are no major surprises. As such, investors who have been reducing their short duration stance, or thinking about doing so, may now be reconsidering and positioning for higher rates.
About the Bond Bulletin
Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.
Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.
Fundamental factors include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings and leverage metrics)
Quantitative valuations is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors)
Technical factors are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum