Why interest rates are heading toward zero (even in the US)

Sculpture by Jimmie Durham, titled ‘Still Life with Spirit and Xitle,’ made of car, volcanic stone and acrylic paint at the Hirshorn museum in Washington, DC. Photo taken July 2018.Sculpture by Jimmie Durham, titled ‘Still Life with Spirit and Xitle,’ made of car, volcanic stone and acrylic paint at the Hirshorn museum in Washington, DC.

The European Central Bank’s (ECB) decision to ease monetary policy even further into negative territory is a “game changer,” set to force the hand of the Federal Reserve and other global central banks, Markus Schomer, chief economist at PineBridge Investments, said Monday.

In September, the ECB cut its deposit rate to negative 0.5 percent, a record low, from negative 0.4 percent previously; the central bank will also restart its quantitative easing (QE) program, planning bond purchases of 20 billion euros a month, starting in November.

“If [other central banks] don’t follow, your currency will appreciate, it’ll kill your export industry; everybody has to follow,” he said to reporters at a press event in Singapore. “The impact of QE will be to drag all bond yields in Europe down towards zero. And as a result of that, all bonds yields around the world will be dragged down, maybe not necessarily to zero, but it will be with intensifying downward pressure.”

Schomer said the monetary policy cycle has become increasingly removed from the macro-economic cycle, with individual countries’ situations no longer the main driver amid pressure to keep pace with declining long-term bond yields. With structurally low inflation globally, it’s hard for central banks to push back against calls to cut rates, he said.

“I would expect by March of next year, we’ll see bond yields in Europe converging towards zero, even Italy, even Greece, everything towards zero and that will have a global impact,” he said. “You can not have one 1.7 percent bond yields [in the U.S.] and zero in Italy. That’s incomprehensible from an investment perspective, but also from a political perspective. I don’t think the U.S. government will pay 1.5 percent if Italy pays nothing.”

Schomer projected the Fed would cut interest rates to 1 percent by August.

That leaves investors, especially yield seekers, in a quandary as they look for returns.

Sunny Ng, multi-asset portfolio manager at PineBridge, said he was focusing on PMI-related plays, or those affecting the purchasing managers’ index, which typically looks at manufacturing.

PineBridge is expecting a manufacturing comeback, as long as trade war rhetoric doesn’t escalate further.

Ng noted companies have been holding back on investments due to trade uncertainty, but as inventories built up in advance of the U.S. imposing tariffs run down, restocking should drive manufacturing demand. Ng also said he expected “natural capex” ahead, as companies engage in normal equipment maintenance cycles.

Ng said PineBridge was rotating its portfolio away from the U.S., looking toward cyclicals, such as European, Japanese and selective emerging markets. That included IT, industrials, materials and oil and gas, as well as China A-share exposure and South Korea, Ng said.

Ng added that Europe’s small caps were likely to outperform the continent’s large caps as PineBridge expects the euro to rise, which will drag large-cap players on export exposure.

Omar Slim, PineBridge’s senior vice president for fixed income, said he liked Asian investment grade corporate credit, and pointed to strong technicals, with new issuance of the segment relatively low.

He noted that overall, less than 10 percent of the companies in Asia’s fixed income universe get more than 10 percent of their revenue from the U.S., making the segment relatively insulated from the trade war.

PineBridge Investments had US$93.4 billion under management as of end-March.

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