Market Insights – 30th of September 2019

Bond markets continue to thwart expectations as the long-awaited rise in yields moves further out of reach. Over the summer, long-term yields plunged to record lows in Europe and Japan, mainly because of geopolitical tensions and the escalation in the US-China trade war, which have dampened the economic outlook. This prompted an about-turn in monetary policies, and most central banks, including the two biggest, are now looking to stimulate growth. The Fed has lowered interest rates, and the ECB had no choice but to start injecting money into the economy again.

These central bank moves mean that yields are now negative on close to USD 16 trillion in bonds – an unprecedented figure that was unimaginable not so long ago. In Switzerland, yields are below zero on more than 90% of Swiss-franc-denominated bonds, which has never happened before. Yet, while inflation is still largely under control around the world, the risk of deflation is clearly not on the cards either. As most sovereign bond yields – especially those in Europe – are not high enough to offset current or future inflation, we prefer bonds that still offer a positive return. This is the case for the US market, and we are particularly bullish on inflation-indexed Treasuries.

If inflation picks up unexpectedly at the end of the cycle and interest rates come under pressure, these bonds should significantly outperform more conventional issues. Corporate bonds also still have upside potential, as we think the fears of a recession are overblown. We are therefore increasing our exposure to this segment by investing in very-short-term US high yields via a specialised fund. Finally, emerging-market debt – in both international hard currencies and local currencies – can provide an attractive yield pick-up. However, a selective approach is needed when it comes to more volatile investments.

While central bankers in Europe, the USA and China are bringing in stimulus measures, the Bank of Japan (BoJ) has kept surprisingly quiet in recent months. Japan’s manufacturing sector continues to be dragged down by the tariffs on Chinese goods and the uncertainty weighing on corporate spending.

Machine tool orders, a key indicator of the health of Japan’s economy, were down once again in August and have plummeted a total of 42% over 17 months. The services PMI is still above the 50 mark, but consumer confidence continues to wane, as illustrated by the decline in department store sales in July.

Saying that the time is not right for a sales tax hike would be putting it mildly. The VAT increase in 2014 sent Japan into recession, even though the machine tool orders were on the rise. This time the sales tax hike may well be the straw that breaks the camel’s back, as the Japanese economy has already been weakened considerably by the trade tensions. When it comes to loosening its monetary policy, the BoJ does not seem to have many options left.

The sales tax hike scheduled for 1 October will probably be combined with measures aimed at limiting the negative impact on the economy. The timing of this hike is questionable – let’s hope the Japanese government will do a better job with the timing of the potential stimulus.