The market sell-off earlier this year has increased the chance that interest rates will be lower for longer and has driven a convergence between yields in the US and the rest of the world (see figure 1).
Figure 1. Yields converge
Source: Federated Hermes, Bloomberg, as at July 2020.
Prior to this year, the outperformance of the US economy relative to Europe had driven a divergence in interest rates in each region. But the coronavirus pandemic prompted the US to ease its policy stance, taking it one step closer to the ultra-low rates seen in Europe and Japan.
Lower interest rates in the US have far-reaching implications for global asset allocators, given that more than half of global fixed income is denominated in US dollars. As fixed-income markets start to recover from the worst first of the year in two decades, the growing stock of negative-yielding assets will bolster demand for global credit – as will support from central banks and the attractive position of bonds relative to equities.
Moreover, the outside chance that the Federal Reserve follows Japan and Australia and implements yield-curve control will keep interest-rate volatility low, something that has historically supported flows into spread products.