In some ways, it really didn’t matter to Steven Major whether the U.K. voted to stay or to leave.
Sure, as a Brit, Major followed the U.K.’s surprising decision to break with the European Union. And, of course, the 51-year-old Londoner voted (though he politely declined to say whether he was in the “Remain” or “Leave” camp).
But when it comes to his long view on interest rates, bond yields and the economy, Major, who’s proven to be something of a savant as HSBC Holdings Plc’s head of fixed-income research, says Brexit is ultimately little more than a sideshow. Long after the din from the U.K. vote subsides and regardless of what happens in the U.S. presidential election, Major says issues that, at times, have been decades in the making will conspire to depress global growth and keep rates at rock-bottom levels for years to come.
“The real elephant in the room is not the U.K. vote or a Trump presidency,” Major said. “The real elephant in the room is we’ll have low and negative rates for a very long period of time.”
While the Brexit vote roiled financial markets and caused a surge in haven demand, Major says investors in the $100 trillion bond market need to look at deeper structural problems plaguing the world: demographics, the explosion of debt globally and the disparity in wealth between the rich and poor.
Low rates are also a natural consequence of too much government borrowing after the financial crisis. While it gave economies a much-needed boost, the debt burden robbed many countries of their spending power, which could have supported growth over the next decade. This month, the Organisation for Economic Cooperation and Development warned the world economy is slipping into a self-fulfilling “low-growth trap.”
And without a pickup in growth, there’s every reason to believe that investors will continue to seek out the safety of government bonds.
For U.S. Treasuries, the global benchmark for borrowing, Major says yields on 10-year notes will remain pinned close to current levels and end the year at 1.5%. That’s below all other forecasts compiled by Bloomberg last week, which, on average, show that Wall Street sees yields starting to rise.
The 10-year yield tumbled by the most in almost five years on Friday following the Brexit vote and ended the week at 1.56%. It approached the record-low 1.38%, set in 2012. The yield dropped nine basis points to 1.47% as of 10:06 a.m. in New York.
In 2014, when most prognosticators predicted yields would finally rise on the view a stronger U.S. economy would prompt the Federal Reserve to tighten, Major called for Treasuries to remain in demand and 10-year yields to fall to 2.1%. That year, they plunged 0.86 percentage point to 2.17%.
Yet Major bristles at the idea that he’s simply defying the majority.
“Anyone can be a contrarian without doing any work — that’s just saying ‘I don’t agree,”’ he said. “I sincerely believe we have low rates for a very long time. Structural problems are outweighing any kind of cyclical bounce.” If anything, last week’s U.K. vote will only strengthen his lower-for-longer view. While Fed Chair Janet Yellen said future rate increases will depend primarily on U.S. data, she has also cited slowing growth in China and the U.K. referendum as reasons to hold off.
In the futures market, the odds of the Fed increasing rates by year-end plunged to 15% in the aftermath of the U.K. vote on Friday. That compares with 50% before the referendum. Traders have even started to price in a rate cut.
Treasuries have returned 5% this year, the best year-to-date advance since 2010, index data compiled by Bank of America Corp. show. Some measures suggest traders see room for further gains.
Based on options contracts tied to the $9 billion iShares 20+ Year Treasury Bond exchange-traded fund, traders are more bullish about advances over the next month than at any time since late 2014. They’re betting Treasuries will rally over the next three and six months as well.
Amherst Pierpont Securities and Macroeconomic Advisers take the opposite view. In the most recent Bloomberg survey that took place prior to the Brexit vote, they were among the few firms that saw yields on 10-year Treasuries rising to 2.5% or higher by year-end on the back of stronger U.S. growth and inflation. They haven’t been that high since October 2014.
While economists see the U.S. growing just 1.9% this year, that’s still stronger than much of the developed world. Inflation, excluding volatile food and energy prices, has topped 2% for six straight months. What’s more, global yields are already at historically low levels as those on almost $9 trillion of government bonds have fallen below zero.
“Obviously, there are a lot of folks in the market that would come up with a much lower forecast,” especially as negative yields prompt investors to pour into Treasuries, said Stephen Stanley, Amherst Pierpont’s chief economist. “I’m assuming that at some point along the way, Treasury yields are supposed to get back to what the U.S. economic fundamentals would dictate.”
Ken Matheny, senior economist at Macroeconomic Advisers, has a similar view, though he acknowledged “the preponderance of risks to our forecast in the near term are to the downside.” Those included the Brexit vote.
Regardless of where forecasters are now, Major says the likelihood of a U.S. recession over the next two years will probably push the consensus outlook lower. And even if the U.S. avoids that fate, the economy may stall enough so that it feels like a recession, especially for those left behind in the recovery. That’s likely to keep the Fed from raising rates further.
“It looks to me like everyone is going to end up converging on a similar view: the Fed can’t do much,” Major said. “I’m already there. It’s more of a structural story and the Fed for international and structural reasons can’t hike. Others will get there from their more cyclical approach.”