Central Banks and the Search for Yield

Central banks are back in easing mode, to the dismay of coupon-clipping fixed income investors.

As shown in the LPL Chart of the Day, Global Central Banks Back in Easing Mode, central banks around the world are embarking on a marked policy shift as trade tensions pressure the global economy and government becomes more intertwined with policy decisions.

Two of the world’s most influential central banks, the Federal Reserve (Fed) and the European Central Bank (ECB), are eyeing looser policy in the months ahead. We expect the Fed to implement a 25 basis point (0.25%) “insurance” rate cut at its July meeting, and policymakers have already announced plans to end balance sheet runoff in September. The ECB has all but promised a new wave of accommodation, likely through asset purchases.

Easier monetary policy could help jump-start economic growth, but it could also weigh on sovereign debt yields. U.S. yields have been depressed this year partially due to global buying pressure, which could intensify if yields elsewhere fall further.

“Fixed income markets are focused on the Fed, but U.S. monetary policy is only part of the story,” said LPL Research Chief Investment Strategist John Lynch. “Looser monetary policy in other regions could increase the allure of U.S. sovereign debt, especially as a source of income.”

Lower-yielding debt could also fuel risk appetite as investors search for yield. That dynamic may boost stock-market gains in the short term, but it can lead to excesses in the financial system. Right now, global fixed income markets are bloated with about $12 trillion in negative-yielding debt, near a multi-year high.

We still think solid economic fundamentals will eventually overpower the worldwide appetite for U.S. debt, though, and a Fed rate cut could help stoke growth on this side of the pond. As mentioned in our Midyear Outlook 2019, we expect the 10-year yield will rise to 2.5–2.75% over the next 6 to 12 months.

For more of our thoughts on recent monetary policy developments, check out this week’s Weekly Economic Commentary: Central Bank Check-In.

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