The era of extraordinary monetary policy continues

Few investors anticipated that Federal Reserve Chairman Jerome Powell could sound even more dovish than he has in recent months. But, at the last FOMC meeting, he managed to do just that. Powell’s message was, in fact, so dovish that recession fears are now popping up everywhere.

No rate hikes this year and an end to the balance-sheet rundown in September due to slower growth: these are the key takeaways from the Fed’s latest decisions on monetary policy. The extremely dovish tone has since caused a collapse in bond yields around the world. As the chart above reveals, the average yield on global government debt currently stands at 1.18%, down from 1.62% in early October. In Germany, the benchmark 10-year Bund yield has fallen below zero again.

USD 10 trillion

The sharp decline in bond yields means that the total amount of outstanding, negative-yielding debt has once again ballooned to above USD 10 trillion. Or, put differently, almost 20% of all outstanding debt ‘earns’ investors a negative return. And, given the synchronized U-turn in monetary policy, this number is unlikely to shrink in the near term.

Market implications

The increased dovishness of central banks is likely to prevent any meaningful rise in bond yields in the near future. This means government debt looks less unattractive than a couple of months ago. Yet we remain cautious about future returns. Although, as mentioned above, 20% of bonds are negative-yielding and yields generally remain very, very low – and significantly below inflation – even lower yields are required to provide a decent return.

Obviously, a recession would push bond yields down further. The odds of this have increased in recent weeks, so we have scaled back our positioning in equities, but it’s not yet a given. The non-manufacturing side of the economy, low unemployment levels around the world and various market indicators such as spreads suggest it could be too early to prepare for such a downturn. However, even if we are spared a recession for a while longer, the era of extraordinary monetary policy is likely to continue for the time being.

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