Predictions of Future Bond Yields Rely Too Heavily on Forward Rates

ING Investment Management is warning investors against relying on forward interest rates when trying to estimate future bond yields, describing them as nearly ‘worthless’.

A forward rate is a theoretical expected yield on a bond several months or years from now, generated by subtracting the yield of a shorter maturity bond from the yield of a longer dated bond.

The investment manager is concerned that forward interest rates are currently being relied upon to advance the argument that future economic growth, inflation and bond yields will be lower than in the past. The relatively low forward rates implied by today’s bond prices are a seemingly objective measure that can be used to support “secular stagnation”, which is the idea that the world has shifted permanently into a lower growth mode. Applying this concept to today’s markets, the US Treasury five year note will yield approximately 3.34% on August 4th 2019 and the Bundesobligation five year will trade at approximately 1.97%.

However, analysis by ING IM reveals that using August 4th 2009 bond yields, the US Treasury five year note should be trading at 4.68% today and the Bundesobligation five year should be 4.18% – instead they are trading at 1.63% and 0.29%, respectively.

Tim Dowling, Head of Global High Yield, ING IM said: “Forward interest rates may be an objective measure, but they are close to worthless as a predictor.’’

“The main benefit from looking at the relationship between shorter and longer dated bonds is that it can provide some insight into trading levels a couple of months out, rather than five years from now. Making predictions that are more than a year away is little more than guesswork. The relationship of shorter and longer dated bonds really only helps with understanding how investors are anticipating short term price reactions.”

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