Bond markets have stabilised following the extreme shock to markets in March, as governments and central banks stepped in to help alleviate financial and market stress. Their responses have been relatively swift and extensive compared with past crises such as the Global Financial Crisis. This has so far helped prevent an even greater economic decline, through interest rate cuts, bond buying, lending programmes and providing liquidity.
We are now, arguably, entering a new phase in which markets will come to terms with the fact that the macroeconomic environment will be challenged. It may take years, not quarters, to return to Q4 2019 levels of gross domestic product (GDP). Unemployment rates are also likely to remain elevated. It seems more likely that the real economy will see something shallower than a V-shaped recovery (which is typically characterised by a quick and sustained recovery in measures of economic performance after a sharp economic decline). The temporary shutdown of the global economy is a unique event and it will take time to recover.
As we enter this new reality, it is becoming increasingly clear that the low interest rate environment that has prevailed in recent years is probably here to stay at least over the medium term. Central banks will likely err on the side of being conservative and accommodative – or, in other words, will seek to implement measures designed to stimulate the economy when it is slowing such as lowering interest rates or quantitative easing. For instance, the federal funds futures market, which represents market participants’ expectations of where interest rates are heading, is pricing the federal funds rate at 0%–0.25% well into 20231. We can expect to see the balance sheets of the European Central Bank, Bank of Japan and US Federal Reserve (Fed) reaching a combined US$20–25 trillion2. There will likely also be many more announcements of fiscal stimulus programmes and extensions of expiring programmes.