Update Bonds: Will central banks push yields down?
A rise in Japanese yields pushed up yields in Europe and the US this week after a long weekend including Thanksgiving and Black Friday. During this week, investors increasingly focussed on the Federal Reserve again.
The US central bank is now widely expected to cut rates next week, although recent data on inflation and unemployment will still be missing, despite an end to the government shutdown.
US President Donald Trump has said that he has made up his mind on the next Fed Chair after current Chair Jerome Powell completes his term in May 2026. Although it is not yet official, it will probably be Kevin Hassett, Chair of the National Economic Council and a key figure in the first Trump administration. Kevin Hassett has been relatively quiet on the institutional makeup of the Fed, such as reducing its size and scope and scaling back quantitative easing, but he is widely viewed as loyal to Trump and in favour of aggressive rate cuts.
Recently, Trump has become less vocal in pushing the Fed to cut rates much further, perhaps because inflation is still a very important concern for US voters, and there are mid-term elections within 12 months. Nevertheless, investors should brace for a significant dovish shift of the Fed next year, with a new Fed Chair and a rotation towards more dovish voting members in January. On top of that, there is the possibility of even more tax cuts or cash handouts next year, as the November mid-term elections draw near.
While central banks may be able to push short-term yields lower, concerns about Fed independence, government debt sustainability and longer term inflation risks are still likely to push up long-term yields. Although the European Central Bank (ECB) is currently very comfortable keeping rates on hold at 2%, aggressive rate cuts in the US could at some point force the ECB to consider rate cuts again. In Europe too, governments will issue more debt next year to finance increased spending. Meanwhile, the ECB has recommended traders to be on alert around year-end, as a large portion of Dutch pension funds are transitioning to a new regime that allows them to sell part of their allocations to very long government bonds.
Reducing duration across the board in such an environment can be counterproductive, as some segments can still perform well. (Duration is a measure of a bond’s sensitivity to changing interest rates.) A careful yield curve policy could be more successful.