In 2013, Wall Street analysts worried that benchmark borrowing costs were about to skyrocket.
When yields plunged in 2014 and 2015, analysts warned rates could increase soon. This year, even as the Federal Reserve deliberates about when to raise overnight interest rates, the question has increasingly been how low can U.S. bond yields go?
But analysts at J.P. Morgan Asset Management think that's the wrong question. They still envision higher rates in the relatively near future. They believe the Fed needs to raise benchmark U.S. borrowing costs soon, in part to dampen the zeal for higher-yielding assets that has pushed investors to take bigger and bigger risks.
“By keeping interest rates this low for this period of time, they risk inflating the sort of search for yield that makes people buy stuff at yields that maybe don’t make a great deal of sense in the long term,” Michael Bell, global market strategist, said on Friday during an interview on Bloomberg Television.
The implication is that a Fed rate increase will dampen the allure of more-speculative investments and even spur higher long-term rates. And that's anything but certain.
In some ways, Bell has a point. It's unnerving that money is flooding into emerging-markets corporate debt at an accelerating pace, making these economies more vulnerable to a sudden reversal of sentiment. And practically every day another big money manager waxes catastrophic about the high U.S. equity valuations, which are difficult to rationalize from any historic perspective.
But even if the Fed raises overnight rates soon, it's not obvious see how another 0.25 percentage point increase will significantly reduce the demand for riskier securities globally. While emerging-markets securities are typically vulnerable to Fed rate increases, for example, "the reaction is likely to be muted at the next rate increase," BlackRock's Richard Turnill wrote in recent commentary.
Recent history is on BlackRock's side. Since the Fed lifted overnight rates in December for the first time in almost a decade, yields on everything from Treasuries to junk bonds to debt of developing nations have plunged, leading to gigantic returns on fixed-income investments.
While the Fed's overnight rate is an important benchmark, one that can have a significant effect on bank earnings with even a small boost, it's not the main factor driving longer-term debt values at this point.
Investors are being pushed into corporate debt globally as the Bank of England and European Central Bank buy investment-grade securities in the region. While the Bank of Japan appears to be running out of ammunition with its stimulus, it has a long way to go before it starts tightening policies.
Meanwhile, investors have responded to any hint of a near-term U.S. rate increase by buying longer-term bonds and selling shorter-term ones. This is essentially a wager that any tightening in the near future will just slow already lagging growth in the longer term. This would prolong the low-rate environment that has nurtured the demand for riskier securities.
In the most drastic scenario, the Fed could empty its balance sheet, flooding the market with Treasuries and substantially pushing up longer-term yields, but it's shown no inclination to do so in the near term. While some investors are increasingly worried about inflation, others, including the Fed, are more sanguine about how quickly consumer prices will rise.
The Fed has long since become the only game in town. While J.P. Morgan Asset is right to worry about riskier securities becoming increasingly overvalued, a Fed rate increase won't necessarily put a quick end to the party.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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