Thought experiments on what constitutes a regime shift

We went back to the 1960s and the period of above-trend growth that sowed the seeds of the 1970s inflation. If that’s what investors think is coming next then they better prepare for an additional 150bp increase in longer-run real rates, and that’s on top of what’s already occurred. For perspective, a further increase that takes forward bond yields towards 4.0% would represent a reversal of all the declines since the Global Financial Crisis (GFC). It is not our view, just a description of what regime shift in the FOMC’s and bond market’s long-run rate outlook might look like.

The evolution of our view – checking back

This is not the first time the low rate regime has been challenged, and it will probably not be the last. Cyclically driven yield forecasts and market moves have oscillated between recession and reflation expectations. Some forecasters forever look for higher inflation but we don’t see what would change the multi-decade trend of lower yields and inflation. Lower-for-longer started with the QE that came after the GFC in 2008-09. The regime withstood the test of ‘taper tantrum’ (2013) and the ‘Trump bump’ (2017). It is now grappling with the ‘Biden bazooka’.

Central banks can only watch falling longer-run real rates

HSBC’s economics team sees a 6% 2021 US GDP (The great experiment, 24 March 2021), reflecting the challenge of the 2021 growth surge. Unlike the economy, the Fed has had its own regime change: it now looks to a longer-run average of realised inflation, and the policy review is not scheduled for five years. Applying a long-run average to growth and inflation forecasts for the coming years finds a return toward trend, not a new regime. By definition, the structural and secular forces that gave us low rates are not likely to reverse quickly. Central banks cannot do much about the birth rate, or make old people young again, neither can they make the debt overhangs vanish.

No change to our longer-run forecasts

Our longer-run 1.0% US 10-year Treasury forecast is unchanged, because we believe the lower-for-longer framework remains intact. Fundamentally driven, longterm investors, may require an event or a trigger that changes the narrative before they can step-in to buy bonds. For our near-term forecasts, neutral means neutral; we regularly update our tactical view in our Fixed Income Asset Allocation publication, the latest of which was published on 10 March 2021.