Bloomberg, May 16, 2016
To Thomas Costerg, the big question for bond investors isn’t whether the Federal Reserve will raise U.S. interest rates this year.
As a senior economist at Standard Chartered Bank, Costerg says the risk of a recession will cause the Fed to backtrack on its move to end seven years of near-zero rates. That will underpin demand for Treasuries and push benchmark 10-year yields to 1.6 percent, one of the lowest forecasts in Bloomberg’s latest survey.
|Forecaster||Firm||Highest 2016 Yield Forecasts (%)|
|John Dunham||Guerrilla Capital||3.53|
|Stephen Stanley||Amherst Pierpont||2.80|
|Scott Brown||Raymond James||2.61|
|Forecaster||Firm||Lowest 2016 Yield Forecasts (%)|
|Paul Mortimer||BNP Paribas||1.50|
|Thomas Costerg||Standard Chartered||1.60|
|Sergio Capaldi||Intesa Sanpaolo||1.60|
|Mikhail Melnik||Kennesaw State Univ||1.67|
Their conflicting views are emblematic of how little consensus there is over the direction of the U.S. economy — and its impact on the $13.4 trillion market for Treasuries. The divide also reflects how mixed policy signals from Fed officials, worries about China and negative rates in Europe and Japan have raised the stakes for investors as yields plunge and bond prices soar. In 2016, the gap between bullish and bearish forecasts is wider than it’s been in each of the past three years as bouts of volatility plague the financial markets.
“If you followed, strictly speaking, the Fed’s forward guidance, the Fed should have hiked rates a lot more and a lot earlier,” Costerg, 30, said in a telephone interview from Standard Chartered’s office in midtown Manhattan. “Some forecasters have fallen into that trap. That’s been the red herring.”
Over the past three years, it’s paid to listen to the bond market’s biggest bulls. Since peaking at 3 percent at the end of 2013, yields on benchmark 10-year Treasuries have tumbled as disappointing inflation and wage numbers, as well as lackluster global growth, kept haven assets in demand.
Ten-year yields, which have declined more than a half-percentage point this year alone, were little changed Monday at 1.71 percent as of 9:57 a.m. in London. Yet even as Treasuries have rallied in 2016 and pushed down the average yield projection to 2.21 percent as of May 12 from 2.8 percent, individual forecasters are splitting further apart.
In Bloomberg’s May survey of 66 strategists and economists, BNP Paribas SA had the lowest official forecast at 1.5 percent, while Brooklyn-based research firm Guerilla Economics had the highest at 3.53 percent. That’s pushed the average gap between the highest and lowest estimates this year to 1.96 percentage points, which is the widest since at least 2013, according to data compiled by Bloomberg.
Costerg, who hasn’t ruled out the possibility that yields will return to the all-time low of 1.38 percent, bases his year-end projection on the view that there’s a 50 percent chance the U.S. will sink into a recession during the next 12 months. That will derail the Fed’s goal of two rate increases in 2016 and prompt the central bank to reverse itself and lower its target by a quarter-point.
The rate is currently a range of 0.25 percent to 0.5 percent.
Amherst Pierpont’s chief economist Stanley, who has consistently been among the most bearish bond-market forecasters surveyed by Bloomberg, says market watchers are underestimating the U.S. economy’s growth potential.
Although headline inflation remains below 1 percent, consumer prices excluding volatile food and energy costs have exceeded 2 percent for five straight months. That’s the longest streak since early 2012. Wages have also picked up, with year-over-year growth averaging 2.4 percent this year, the highest in seven years.
Greater earning power has bolstered American consumers. Retail sales in April rose by the most in 13 months and consumer confidence surged in early May to an almost one-year high as households were the most upbeat about their inflation-adjusted incomes in a decade.
“I’m taking a look from 30,000 feet at the historical relationships between the economy and rates,” said Stanley, 47. Investors “conclude inflation will be low for a long time and the Fed is almost powerless to achieve its target. We’re starting to see evidence of a gradual move higher in wages. They are going to have to bite the bullet and start normalizing rates.”
Yet it’s still too soon to conclude the U.S. economy is back on track.
Weaker-than-forecast quarterly earnings reports have come from tech companies including Apple Inc., Microsoft Corp. and Google parent Alphabet Inc., while Walt Disney Co. and Macy’s also reported disappointing results.
Meanwhile, employers added the fewest number of workers in seven months as April payroll figures fell short of economists’ forecasts. That prompted Goldman Sachs Group Inc., Barclays Plc and Bank of America Corp. to push back their rate calls and buoyed bullish debt investors who see no end to years of tepid growth and inflation.
Futures traders aren’t convinced by the U.S. growth story, either. They’re pricing in just a 4 percent chance the Fed raise rates by June, down from 75 percent at the start of this year. The likelihood of a move by year-end, which was once a near certainty, is now little better than a coin flip.
“There are so many reasons for yields to be pulled lower,” said Timothy High, a New York-based U.S. interest-rates strategist at BNP Paribas.
Part of the disparity among forecasters has to do with conflicting signals from officials at the Fed itself.
On May 12, Kansas City Fed President Esther George reasserted her call for higher rates, saying current levels are “too low for today’s economic conditions.” A day later, Fed Governor Lael Brainard said the central bank risks moving too quickly if it underestimates the impact that the world’s major economies could have on U.S. growth.
And that’s particularly important now as the European Central Bank and the Bank of Japan experiment with negative interest rates to spur their flagging economies, while bond-buying stimulus has caused debt prices to soar and pushed yields on more than $9 trillion of securities below zero.
Forecasting “used to be all about the business cycle,” said Krishna Memani, who oversees $204 billion as chief investment officer at Oppenheimer Funds Inc. “What’s going on in terms of policy easing around the world has had a bigger impact.”