The odds of the U.S. entering a recession over the next year are now the highest since the current expansion began seven years ago, according to JPMorgan Chase & Co. The Organisation for Economic Cooperation and Development also warned this month the global economy is slipping into a self-fulfilling “low-growth trap.” What’s more, Britain’s vote on whether to leave the European Union this month has been a major source of market jitters.
“Markets are becoming increasingly convinced that developed nations may be less able to create inflation even if they want to,” said Neela Gollapudi, the head of portfolio management and research at Gentrust Wealth Management, which oversees $1 billion.
Last year, inflation in developed economies slowed to 0.4 percent and is forecast to reach just 1 percent in 2016 -- half the 2 percent rate most major central banks target, data compiled by Bloomberg show.
Yet some say that quantitative easing, or the aggressive bond-buying stimulus that central banks in Europe and Japan are currently pursuing, is causing many debt markets to become unmoored from their fundamental value.
That may help to explain the record demand at U.S. government debt auctions this year. With almost all the negative-yield debt concentrated in the euro area and Japan, investors are pouring into Treasuries, which offer some of the highest yields in the industrialized world. Demand at sales of two-, five- and seven-year notes last month soared to all-time highs, according to data compiled by Bloomberg. Foreigners also bought the most Treasuries at the May auctions since 2011, data compiled by TD Securities showed.
An unintended consequence of QE is that it leaves “an asset price devoid of its valuation,” said Jim Caron, a money manager at Morgan Stanley Investment Management, which oversees $406 billion.
Based on relative value to stocks, U.S. government bonds are overpriced. Yields on the 10-year note were at 1.62 percent today, set for the lowest close since 2012. That’s about a half-percentage point below the 2.17 percent dividend yield for the S&P 500. On that basis, Treasuries have been more expensive than U.S. equities for five months, which has occurred on only two other occasions -- in 2008 and 2012, data compiled by S&P Global Inc. show.
Treasuries went on to post their worst annual returns on record, losing 3.7 percent in 2009 and 3.4 percent in 2013, according to index data compiled by Bank of America Corp.
“There’s more risk in the bond market,” said Keith Wirtz, the Minneapolis-based chief executive officer at Walrus Partners.
Some of the bond market’s brightest luminaries are sounding the alarm over the potential fallout. Gross, the manager of the $1.3 billion Janus Global Unconstrained Bond Fund, said that ultra-low bond yields worldwide are a “supernova that will explode one day.”