Macroscope | For investors watching the US Treasury yield curve, it’s OK to be cowardly – debt issuance isn’t going anywhere

There are three scenarios investors can take – one optimistic, one dark and one ‘cowardly’, in which rates hover around 1.5 per cent

For the time being, companies look comfortable taking on debt, which means the latter option is still the best bet

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A trader works on the floor of the New York Stock Exchange on September 16. The Dow was down over 130 points as investors reacted to a weekend drone attack on a Saudi oil field and a United Auto Workers strike at General Motors. Photo: Getty Images/AFP

Published: 2:00pm, 18 Sep 2019Updated: 10:36pm, 18 Sep 2019

While most of the financial world stares at the US Treasury curve with a mix of discomfort and confusion, those investors who are taking a view mostly line up around three forecasts for 10-year yields. These predictions may be carefully modelled and explicit, or they could be more like a feeling in their bones. But it helps to know where you line up as you put your own money on the table.

So pick a number. If you choose 3 per cent, you believe the reflationary case that yields will drift higher over the next 12-18 months. The darker scenario has rates dropping to zero along with a variety of associated cataclysms, plagues and locusts. The cowardly case, which simply projects the recent past into the foreseeable future, assumes rates will hover around 1.5 per cent.

At this stage, the overwhelming evidence supports the cowards. But let’s examine them in turn.

While a world in which rates hit 3 per cent may offer the best outcome for the global economy, it probably represents the biggest risk to investors. The stalwart defenders of the Phillips Curve, which has traditionally linked lower unemployment with higher inflation, have dwindled to a precious few. This means there is a lot of money that has been invested on the continuing promise of very cheap funding.

There’s still a long list of structural forces likely to keep wages and prices in check: competition from low-wage countries, automation that replaces physical labour, weaker trade unions and an expanding share of service jobs. Still, if prices started rising from, say, a spike in commodity prices or regional conflict, the jolt to the financial system from higher interest rates would be considerable.

Fires burn in the distance after a drone strike on Aramco's oil processing facilities in Buqayq, Saudi Arabia, on September 14. Photo: Reuters

.css-1m2rp1p{color:#34b8b5;}Macroscope | For investors watching the US Treasury yield curve, it’s OK to be cowardly – debt issuance isn’t going anywhere

Macroscope | For investors watching the US Treasury yield curve, it’s OK to be cowardly – debt issuance isn’t going anywhere