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What is behind the rise of global bond yields?
Fixed Income Research – What is behind the rise of global bond yields?
Highlights
- The rise of US yields is driving up yields around the world.
- We expect higher volatility in global rates, amplified by geopolitical risks and commodity price movements.
- Structural headwinds and accommodative foreign monetary policies will likely limit the rise US yields over the medium term.
Since last November, investors’ sentiment has turned into ‘risk-on’ mode, favouring risky assets and equities relative to bonds. The rise in global yields and the steepening of yield curves has fuelled fears about the end of the 35-year bond bull market.
US yields drive up global yields
Since the early 2000s, the rise of global financial integration (i.e. the increase movements of capital between economies) has been reflected in higher co-movement in global yields. The chart below shows that almost 60% of the changes in bond yields of advanced economies (US, UK, Germany, and Japan) may be explained by a common factor.
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The recent rise of global yields was predominantly driven by the rise of US yields along with cyclical factors (such as inflation, geopolitical risk and market volatility). However, we believe the ongoing accommodative monetary policies in Europe and Japan are likely to keep bond yields low in these regions, limiting the rise of US yields over the medium term.
What is driving US yields higher?
Long-term bonds yields are a function of the expected future short-term interest rates and the bond term premium that investors require to buy long-term bonds rather than roll over a series of shorter maturity bonds (i.e. inflation risk premium). The trend decline in global yields in the past 35 years mostly reflects the trend decline in bond term premium, while expected short-term interest rates fluctuate along with the changes in monetary policies.
Expected short-term rates started to increase in December 2013 when the Fed announced the tapering of its monthly bond purchases. However, US bond term premiums continued to decline and then slipped into negative territory in the first half of 2016 – for the first time in history. Deflation fears fuelled by the 70% drop of energy prices between 2014 and 2015 negatively affected inflation risk premiums, which declined from 0.5% to -0.5%. The sustained rebound in energy prices since February 2016 enabled inflation premiums to bounce back in Q4 2016, leaving both forces – bond term premium and expected short-term rates – trending upward. As a result, US long-term yields started to rise.
We evaluate the current mispricing of the 10yr treasury yield at 10bps tighter than its estimated value, based on the gap between the current 10yr yields and the sum of its two components. Thus, we believe most of the expected three rate hikes from the Fed this year have already been priced into 10yr yields. However, we expect higher rates volatility amplified by elevated volatility in energy prices and geopolitical risks. The MOVE index (an indicator of bond markets volatility) has increased 20% since Q4 2016.
Structural headwinds push yields down
The recent tightening in US financial conditions has been driven by the prospect of a better economic outlook in the US, reflecting current expectations of larger fiscal policy stimulus. In our opinion, the efficiency of the fiscal stimulus and its effects on bond markets will crucially depend on its fiscal neutrality and on its capacity to boost productivity and labour force growth. While the labour force growth has rebounded since 2012 under the accommodative monetary policy of the Fed, US productivity growth remain low from an historical perspective and continue to weigh on the economy.
Historical data reveals a strong positive relationship between investment and labour productivity.
The decline trend of investment in advanced economies can be partly explained by high credit constraints. The Debt Service Ratio (DSR) or the share of income used to service debt has not yet return to the pre-crisis levels, weighing on consumption and investment.
Subdued long-term economic trend limit yields’ rise
The gradual decline in the US GDP growth trend has led to gradual similar decline in the neutral real interest rate (i.e. the federal funds rate that neither stimulates nor restrains economic growth), which, in turn, has caused the decline in long-term interest rates. The US Congressional Budget Office (CBO) forecasts a stable 2% potential real GDP growth – the highest level of real GDP that can be sustained over the long term – for the US economy over the next 10 years. Accordingly, the neutral real interest rate for the US is expected to pick up and move in tandem with the potential real GDP. Although, both remain lower from a historical perspective.
This analysis is consistent with the gradual downward revision of long-run projections from the FOMC. From 2012 to today, the FOMC gradually revised downward its estimates for the long-run potential GDP growth rate and the terminal fed funds rate (or neutral interest rate) from 2.4% to 1.8% and from 4.25% to 3.00% respectively. Fed Chair Yellen reiterated in January1 that the Fed expects to increase Federal Funds rate target a few times a year until, by end of 2019, it is close to its longer-run neutral rate of 3%. Accordingly, we expect the Fed to hike rates three times this year.
We expect the trend rise of the US yields to be gradual over the medium term toward 2019 amid higher volatility. The upside risks to this view would come from a significant and quicker-than-expected rebound in productivity growth and inflation.
For more information contact:
ETF Securities Research team
ETF Securities (UK) Limited
T +44 (0) 207 448 4336
E info@etfsecurities.com
Important Information
The analyses in the above tables are purely for information purposes. They do not reflect the performance of any ETF Securities’ products . The futures and roll returns are not necessarily investable.
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This communication has been provided by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).
This communication is only targeted at qualified or professional investors
Every month, our research team will present the cryptoassets of the month that increased or dropped in value by more than 15%. With a data-driven approach, we highlight the most important developments and events causing price movements.
Figure 1 – 30-Day Performance: Cryptoassets of the Month vs. Traditional Asset Classes
Data Source: 21Shares, CoinGecko, and Yahoo Finance, from 30-Apr-2023 to 31-May-2023 (Close Price)
Ethereum (ETH)
Ethereum traded down 0.57% over the past month. On May 15, Lido V2 went live, enabling users to withdraw their stETH (staked Ether). As of May 31, Lido has processed over 460k stETH withdrawals without voluntarily exiting a single validator. The protocol achieved this by implementing a buffer that accumulates ETH via daily deposits, partial withdrawals, and rewards. On the scaling front, Aztec revealed its “hybrid zk-rollup,” which will enable private smart contract execution, allowing users to protect their data and on-chain activity with programmable anonymity. Finally, Ethereum’s beacon chain suffered a technical issue that caused the network to stop finalizing blocks briefly.
Bitcoin (BTC)
Bitcoin traded down 7.21% over the past month. On May 17, Tether announced it would use 15% of its monthly net operating profits (i.e., the realized gains from T-bills and similar investments) to buy Bitcoin. The move aims to diversify Tether’s reserve surplus. In addition, it could have a considerable effect on BTC’s structural supply and demand dynamics, as it can offset a significant portion of the selling pressure we can expect from the 41k BTC that the U.S. government intends to sell this year. On another front, transaction fees on the Bitcoin network rose five-fold from $23.5 million in April to $124 million in May, primarily driven by Ordinals and BRC-20 tokens.
Decentraland (MANA)
Decentraland (MANA) traded down 15.08% over the past month as activity in the decentralized virtual world waned significantly. About 2,740 unique wallet addresses interacted with Decentraland throughout May, down ~26% from April. In other news, on May 18, Decentraland DAO introduced “Decentraland Studios,” a platform to connect creators who want to build experiences on the platform but lack the technical skills to do it. This move is part of a broader trend in crypto attempting to lower the barrier of entry for new developers and creators.
Stacks (STX)
Stack’s native token STX traded down 16.47% over the past month. On May 23, ALEX – the most prominent decentralized exchange (DEX) on the Stacks network – introduced permissionless listings for BRC-20 tokens. Despite the combined market cap of BRC-20 tokens reaching close to $500 million, they mainly consist of “meme coins” because Bitcoin does not natively support smart contracts, nor is it designed for fast performance. Thus, Bitcoin needs Layer 2s like Stacks to be usable at scale and open the segway for new use cases. Regarding ecosystem traction, the Stacks networks reached 65,000 deployed smart contracts on May 25.
Avalanche (AVAX)
Avalanche’s native token AVAX traded down 17.85% over the past month despite exciting ecosystem developments. On May 24, Ava Labs announced AvaCloud, a launchpad that allows businesses to deploy custom, fully managed blockchains using an intuitive no-code portal. In addition, the AvaCloud product suite includes managed validators with automated installation for enhanced security, comprehensive data tools, and chain interoperability between all blockchains on the Avalanche network. If successful, the release could mark a paradigm shift in enterprise adoption by removing the complexity of building a public or private blockchain.
Algorand (ALGO)
Algorand’s native token ALGO traded down 18.34% over the past month, underperforming the broader market. The Algorand Foundation recently released AlgoKit, an application that handles the developer environment setup, project generation, and deployment. AlgoKit aims to lower the barrier of entry for developers entering the ecosystem. In this regard, attracting new talent is an area Algorand has struggled with – the blockchain had only 38 full-time developers as of April 2023, according to Electric Capital. The network’s inability to attract new talent may be worrisome as developer engagement is an early and leading indicator of value creation.
Fantom (FTM)
Fantom’s native token FTM traded down 26.28% over the past month. On May 8, the Fantom Hackathon Q2 2023 opened for submissions with a prize pool of over $300k for innovative dApps built on the blockchain. On May 17, the Fantom Foundation released Fantom Academy, a series of lessons for developers, including Solidity basics, token standards, and more. Finally, regarding ecosystem traction, Fantom became available on The Graph, allowing developers to leverage subgraphs to load data on the Fantom blockchain securely and reliably into their dApps.
Strategies of the Month: March 2023
Every month, our research team will also present the best-performing strategies of the month in our product suite. With a data-driven approach, we highlight the most important developments and events causing price movements.
Figure 2: 30-Day Performance: Strategies of the Month vs. Traditional Asset Classes Data
Source: 21Shares Index Management Console and Yahoo Finance, from 28-Apr-2023 to 31-May-2023 (Close Price)
SBTC
The 21Shares Short Bitcoin ETP (SBTC) rose 5.72% over the past month. SBTC seeks to provide a -1x return to the performance of Bitcoin for a single day. Despite its strong fundamentals, BTC’s implied annual volatility has consistently been above 70% and has experienced drawdowns from its all-time high of more than 80%. By comparison, the annual volatility of the S&P 500 sits around 20%. As a result, sophisticated investors with stringent risk-management practices may benefit from tactical short-term inverse exposure to BTC.
Research Newsletter
Each week the 21Shares Research team will publish our data-driven insights into the crypto asset world through this newsletter. Please direct any comments, questions, and words of feedback to research@21shares.com
Disclaimer
The information provided does not constitute a prospectus or other offering material and does not contain or constitute an offer to sell or a solicitation of any offer to buy securities in any jurisdiction. Some of the information published herein may contain forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained herein may not be considered as economic, legal, tax or other advice and users are cautioned to base investment decisions or other decisions solely on the content hereof.
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