This Guy Called Bonds in ’14. You Listening This Time?

Updated on
Steven Major
Steven Major, the London-based head of fixed-income research at HSBC Holdings Plc. Source: HSBC via Bloomberg

Steven Major did something weird in 2014: he got the bond market right.

When most experts said sell, Major said buy. And he’s defying the consensus again this year.

Wall Street, as a whole, is still pointing the other way -- but then, Wall Street, as a whole, blew it last year.

Major, the London-based head of fixed-income research at HSBC Holdings Plc, stood out for correctly predicting that 10-year Treasury yields would drop to about 2.1 percent. Others said yields would approach 4 percent.

“Some investors thought we were completely bonkers,” Major, 50, said of his 2014 call.

Now, Major says yields will keep falling, possibly as low as 1.5 percent, before turning up to end the year at 2.5 percent. Wall Street sees the market headed for a big selloff as the Federal Reserve starts raising interest rates. The median estimate of 74 forecasters in a Bloomberg survey is for 3.01 percent by year-end.

Major dismisses concerns about the Fed. Instead, he sees parallels between the weak global economy in the years immediately after World War II and the state of things today. Back then, slow growth pinned Treasury yields below 2.5 percent.

“I’m sure he will have even bigger following” after last year’s call, Rod Davidson, the head of fixed-income at Alliance Trust Plc, an HSBC client overseeing $5.2 billion, said by telephone from Dundee, Scotland.

Unparalleled Demand

So far, 2015 is already shaping up to be a historic year. Yields on 10-year Treasuries tumbled more than at the start of any year since 1998, ending at 1.95 percent last week. Benchmark rates in the U.S., Germany and Japan fell below 1 percent on average for the first time as deflation emerged in Europe, oil sank below $50 and American wages fell.

Yields on 10-year Treasuries dropped to 1.91 percent today, versus 2.17 percent at the end of 2014.

Major says borrowing costs can stay low for years because debt loads incurred by the largest economies after the financial crisis will drag on growth and constrain their ability to spend.

The global bond market has ballooned more than 40 percent to $100 trillion as governments bailed out the banking industry and plunging tax receipts deepened deficits.

Public debt reached 108 percent of gross domestic product in 2012, a level not seen since World War II ended, according to the International Monetary Fund. Even after some nations adopted austerity measures to restore fiscal discipline, the ratio will be 106 percent this year.

1940s Redux

Central-bank bond buying, which occurred in the 1940s to finance the war and the subsequent rebuilding of Western Europe under the Marshall Plan, may also keep a lid on yields.

Led by the Fed, major central banks have inundated their economies with $10 trillion of cheap cash since the crisis, Deutsche Bank AG said. The Fed’s assets equal about 24 percent of GDP, exceeding the post-World War II high of 20 percent, data compiled by London-based HSBC show. The Bank of England holds debt equal to about 30 percent of GDP.

While both stopped accumulating debt, they’re reinvesting money from maturing securities into more bonds. The Bank of Japan has stepped up stimulus and the European Central Bank may also buy government debt as part of its quantitative easing after inflation in the euro area fell below zero for the first time in more than five years in December.

History Lesson

“We have a backdrop that’s more like the 1940s when governments were saddled with debt after the war and central banks held a big proportion,” Major said.

In the decade starting 1945, U.S. benchmark yields averaged about 2.46 percent, according to “A History of Interest Rates” by Sidney Homer and Richard Sylla.

That hasn’t stopped Wall Street from anticipating a yield surge this year. Based on their projections across maturities, forecasters see the biggest increases since 2009, when Treasuries suffered record losses.

In the minutes of their December meeting, Fed officials signaled stronger economic growth and improving labor markets would likely offset any inflation slowdown caused by oil’s slump. Lower fuel bills will act as a tax cut to boost growth instead, said Mark Dowding, the co-head of investment-grade bonds at BlueBay Asset Management, which oversees $66 billion.

“People are extrapolating low oil prices to mean economic slowdown, but we disagree,” he said by telephone from London.

Conventional Wisdom

Dowding expects 10-year yields to rise toward 3 percent as the Fed lifts rates from close to zero, which economists say will happen in the third quarter.

Even as U.S. employment gains reduce joblessness to the lowest since 2008, the lack of consistent wage growth may undermine the Fed, upending conventional wisdom once more.

Hourly earnings fell 0.2 percent last month, the biggest drop on record. Stagnant wages in 2014 helped hold the Fed’s preferred inflation gauge below its 2 percent goal, fueling bond gains that caught almost everyone off-guard.

While HSBC’s Major says it’s never easy being a forecaster, getting it right last year has had at least one perk: fewer unannounced phone calls from skeptical clients.

“Sometimes forecasts are right for the wrong reasons and/or have had bad timing, but this one was spot on,” Major said, referring to his 2014 projection.

“We should enjoy it while it lasts.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE