Still upside risk to long term bond yields
It is easy to get caught up in the ongoing drama and lose sight of the fundamentals. Valuations are the key determinant of asset returns over the medium term and our view is bonds are still expensive, developed market and New Zealand shares are fully valued, whereas commodities and emerging markets remain inexpensive relative to longer term trends.
The chart below plots global growth versus US 10 year treasury yields, which can be thought of as the global risk free rate. The chart shows a reasonably tight relationship between growth and bond yields.
10 year government bond yields
Source: Bloomberg, AMP Capital
As a result of the move higher, US yields are now closer to fair value. But overall we believe there is still more upside than downside risk to yields as the Fed is still on course to raise rates from zero later this year. With yields below 1% (half their inflation target) we think European and Japan yields are still expensive on a medium term horizon.
US Federal Reserve chair Janet Yellen warned recently of the upside risk to bond yields: “Not only short, but long term interest rates are at very low levels and that would appear to embody low term premiums … which can move very rapidly ... When the Fed decides it’s time to begin raising rates, these term premiums could move up and we could see a sharp jump in long term rates.”
This raises the critical question of how will other assets perform if the Fed hikes rates and bond yields continue to push higher? History can provide some insights here.
This blog post has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act).
An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice.
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