Despite global bond investors being on edge at apparent central bank impotency, the probability of a sizeable bear market is low with a possibility that fiscal policy could prove effective, according to asset manager AlllianceBernstein (AB).
John Taylor (pictured), portfolio manager – AB Dynamic Global Fixed Income Fund, says the major driver of the recent risk-off trade was the use of historically low, and in some cases negative, interest rates by developed-world central banks as they to tried to revive global growth and inflation.
“The countries that have resorted to negative rates to date – Denmark, Sweden, Switzerland and Japan – wanted to create a disincentive for banks and savers to hold money on deposit. In theory, the liquidity would be diverted into the productive economy where it would create jobs, stimulate growth and (the central banks’ ultimate goal) stoke inflation,” says Taylor.
“Instead, much of the liquidity has found its way into non-productive assets such as housing, equities and bonds, creating potential bubbles in those markets. Quantitative easing—whereby central banks have bought bonds to inject liquidity into their financial systems, in the hope that banks would use it to finance the business sector – has had a similar unintended effect.”
Taylor says the big losers have been European banks, especially weaker ones. Their profits have fallen as low interest rates had squeezed loan margins, and their business models have been further eroded by the requirement to pay for keeping money on deposit with the European Central Bank.
Against this background, the focus is shifting to the potential for fiscal policy to break the impasse. Japan was further down the path of exploring this option than other countries, he says.
“While it will take time to judge the effectiveness of Japan’s initiative, it’s not too soon to consider the likelihood of other countries following Japan’s example,” says Taylor. “We don’t expect any move towards aggressive fiscal policy expansion in Europe until after next year’s elections in France and Germany. Political leaders in those countries will want to feel politically secure before embarking on a major budget exercise.”
Taylor says the one thing investors should not expect was further significant easing of monetary policy, as its impact to date had been negligible and further easing might have adverse consequences, especially for weaker European banks.
“At the same time, we don’t see any prospect of aggressive policy tightening: even a US rate rise this year will be small and the Fed is likely to wait a long time – possibly another year – before making its next move.
“In other words, the situation will continue to muddle along for a while with yields remaining at current levels. While this means lower returns for fixed-income investors, it also means that the much feared bear market in bonds remains some way off and, with luck and careful policy management by central banks, may yet be avoided,” he says.
