Yields will remain at their depressed levels unless the global recovery in domestic demand broadens out from the US to Europe and emerging markets, warns Standard Life Investments.
In Standard Life Investments' latest Global Horizons report, co-author chief economist Jeremy Lawson lists the economic and policy drivers of the current low US and global interest rate environment.
"Scarring from the financial crisis and prolonged private sector deleveraging has raised desired savings, weighing on domestic demand and inflation, reinforced by monetary and fiscal policy mistakes," the report said.
"The failure of the US recovery to translate into stronger growth in the rest of the world, restrained by events in the eurozone, has pushed up the value of the dollar and increased the demand for duration."
Standard Life Investments is more optimistic than the 'consensus view' on current long-term interest rates in the US of two per cent.
"We instead expect the policy rate to average between 2.75 per cent and 3.25 per cent over the next decade, as inflation expectations rise to around 2.0 per cent," said the report.
The authors' baseline scenario for US 10-year yields is an increase from the current 2.25 per cent level to between 3.0 per cent and 4.0 per cent "over the course of the current expansion" – a long way below the 5.16 per cent peak of the previous business cycle.
But for such a scenario to eventuate, the most important trigger is a ratcheting up in global spending.
In addition, it is essential that the global recovery in domestic demand continues to broaden out from the US, said the report.
"If the European recovery remains muted, or EM growth deteriorates further, global inflation could moderate rather than increase and other economies will not be able to exit from their own very accommodative policies.
"In these circumstances there will be greater upward pressure on the dollar, any Fed tightening cycle will be cut short and the result could be a strong bid for US duration," said the report.
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