Global Demographics Poised to Deteriorate Further

The secular drivers of low rates—particularly aging demographics—are on the verge of intensifying. As a result, the move to lower rates is likely to give way to either a very low and rangebound rate environment, or even lower rates.

October 25, 2019

Rather than heading off into uncharted waters, PGIM Fixed Income sees the current environment as a continuation of the low and rangebound rate pattern we’ve been in for several years where the investment results are dominated by the same fundamental economic and market trends.

In some ways, they see the secular drivers of low rates—particularly the aging demographics—on the verge of intensifying. As a result, the move to lower rates is likely to give way to either a very low and rangebound rate environment, or even lower rates. As support for this thesis, even the recent steep drop in rates has not boosted growth, inflation, or credit demand. We see that as a litmus test—i.e., do these rates stimulate growth or not? The lack of an uptick in growth suggests that, if anything, rates are still above equilibrium rather than below. As a result, market forces and central bankers are likely to remain aligned in their push for lower rates, setting the stage for long-term bonds to continue outperforming cash, but by presumably smaller margins than in the past.

Since roughly 2010, the share of the world’s population that is of working age (15-64 years) has peaked, and it is now trending down, as shown in the chart below. The United Nations projects that this ratio will continue to fall through 2040.
 

Working-Age Population Share (15-64 years)*

Source: United Nations, Haver Analytics, and PGIM Fixed Income as of December 2018. *Share of total population.

The visual shows the working-age population from 1995 to 2040 for the world, advanced economies and emerging markets. The chart shows that after 2019, the working-age population for all three areas starts to trend down as we go out to 2040, especially in advanced economies.

U.S. Rates: Low for Long, but Likely Positive

The burgeoning stock of negative-yielding debt across the international markets has investors wondering: Will it happen in the U.S. too? Given PGIM Fixed Income’s long-standing “low for long” thesis for the global bond markets, it expects U.S. rates to fluctuate around current levels and ultimately remain positive given some key distinctions between the U.S. and the growing list of negative-yielding countries.

There are two underlying macro factors that have served to keep long-term U.S. rates markedly above those in many other advanced economies—first, somewhat higher inflation and, second, stronger real GDP growth. While one or both of these factors may ease in the years ahead, they are likely to continue to play a role in supporting U.S. rates relative to those abroad.

A second factor is better demographics. Over the past approximate decade, the growth of the U.S. working-age population has exceeded those of the Euro area and Japan by 0.75 percentage points and 1.5 percentage points, respectively (see The Economics of Global Aging: Gray Skies, Rays of Policy Hope?). Over the next couple of decades, the UN projects that U.S. demographics will slow notably, but will continue to substantially outpace those of the other two economies.

Working-Age Population (Average Growth, %)*

Working-Age Population (Average Growth, %)

 

2000-2009

2010-2017

2018-2040(Proj.)

Advanced Economies

United States

1.1

0.5

0.3

Euro Area

0.3

-0.2

-0.6

Japan

-0.5

-1.0

-0.9

United Kingdom

0.8

0.2

0.1

Source: United Nations, Haver Analytics, and PGIM Fixed Income as of December 2018. *15-64 year olds.

In summary, our sense is that the factors that have kept U.S. rates higher than those abroad are likely to remain largely intact in the years ahead, although the gap in rates appears biased to narrow somewhat further over the intermediate to long term. Overall, we continue to expect global developed market rates, including those in the U.S., to remain low by any historical standard. But with downside risks and negative momentum stalking the global economy, at a minimum, there is scope for lower rates, especially in the U.S., and negative rates cannot be ruled out as an outlier scenario.


Footnote

Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by commercial mortgages rather than residential mortgages. They are composed of a variety of loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. High yield bonds, known as junk bonds, are subject to a high level of credit and market risk. International bonds are bonds issued by foreign corporations or foreign government agencies. Emerging market bonds are local currency bonds issued by emerging market governments. Emerging market countries may have unstable governments and/or economies that are subject to sudden changes. These changes may be magnified by the countries’ emergent financial markets, resulting in significant volatility to investments in these countries. Investment-grade corporate bonds are bonds with a credit rating of AAA to BBB as rated by Standard & Poor’s, or Aaa to Baa as rated by Moody’s. Mortgages refer to mortgage-backed securities (MBS), which are composed of a variety of residential mortgage loans, each of which represents different property sizes and locations. These loans are pooled and are broken into tranches of risk that are sold to investors. Collateralized loan obligations (CLOs) are securities backed by a pool of debt, often low-rated corporate loans. Municipal bonds are tax-exempt bonds with a maturity of at least one year, including state and local general obligation, revenue, insured, and pre-refunded bonds. Unlike other investment vehicles, U.S. government securities and U.S. Treasury bills are backed by the full faith and credit of the U.S. government, are less volatile than equity investments, and provide a guaranteed return of principal at maturity. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. Past performance is no guarantee of future results.

The views expressed herein are those of PGIM Fixed Income investment professionals at the time the comments were made and may not be reflective of their current opinions and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither Prudential Financial, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed.

The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.

This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional.

PGIM Fixed Income is a unit of PGIM, Inc. (PGIM), a registered investment advisor. PGIM is a Prudential Financial company. © 2019 Prudential Financial, Inc. and its related entities. PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

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This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional.

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