3. A bond market meltdown isn’t imminent.
Low inflation confirms my 2015 outlook for interest rates. While I expect rates to rise next year, with the US economy slowly normalizing and the Fed likely to take its foot off the accelerator very gradually, rates should rise slowly.
The bottom line: One silver lining of today’s global slow growth environment is that inflation is unlikely to be a problem for now.
Market Realist – Treasuries could continue offering extremely low yields
The graph above shows the yield on the ten-year Treasuries (IEF). Currently, the yield is ~2.1%—compared to the long-term average of around 4.4%.
As we mentioned earlier in this series, inflation stands at 1.3%. Inflation could be heading even lower if crude oil (USO) continues to dip further. Many analysts expect WTI to fall to $40 per barrel. This means interest rates could remain low. This, in turn, could keep Treasury (TLT) yields low for another year. Even if interest rates rise next year, the rise will be modest.
Not too long ago, the search for yield had driven investors to riskier assets like high yield bonds (JNK). This resulted in the credit spread between high yield bonds and Treasuries contracting to a record level. However, high yield bond prices are plummeting currently. This is because the energy sector (XLE) includes a lot of junk bond issuers.
Please read Market Realist’s The New Fixed Income World to learn how the fixed income landscape has changed in the last few decades.