March Outlook
March 11, 2019  |  By Hank Cunningham

After the Federal Reserve was joined on the sidelines by central banks in Canada, Europe, Australia and China, the bond market moved to a state of equilibrium, as bond yields respond to natural market forces.

Monetary policy moved away from further tightening in response to mounting evidence of slowing global economic growth. Some pundits are calling for rate cuts by the central banks.

This recency bias ignores the fact that global growth remains positive but at a slower pace. The U.S. economy is not immune to global conditions and there has been slowing in several key sectors such as auto sales, consumer confidence and home sales. At the same time, markets are catching a whiff of inflation, which has resulted in a steepening of the yield curve, particularly in the widening spread between 10- and 30-year Treasuries. The 30-year bond yield has added 15 basis points since the beginning of the year. Inflation expectations snapped back to near 2% on a 6% increase in commodity prices and wage gains.

There is little stress in the investment grade and high yield markets.

Meanwhile, global bond yields fell sharply. The German ten-year bund sunk to a mere 5 basis points! Thus, the U.S. bond market remains the high-yielding beacon among global bond markets and continues to attract international investors, especially given the strong dollar. Against this tug-of-war, U.S. ten-year bond yields could fall to 2.50%. The Fed is willing to tolerate inflation running above its 2% target, so if inflation does pick up further, upward bias would then return to bond yields, perhaps pushing them to 3%.

Canada experienced a dramatic slowing in GDP in Q4, with weakness in trade and retail sales evident. The Bank of Canada moved to the sidelines and, in a dovish announcement, pared its growth estimates considerably, leaving little doubt that it will remain on the sidelines indefinitely. Thus, Canadian fixed income investors are facing a period of flat to declining yields.

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