How the 'impact of technology’ could be radically reshaping the US bond markets

Key Points
  • Technology will keep a lid on interest rates according to this major asset manager
  • Deflation is everywhere says Jim McCaughan, CEO of Principal Global Investors
  • McCaughan adds there is a 20 percent risk of a major risk event in 2018
US tax cuts impact on individuals will be mixed, CEO says

The sell-off in 10-year Treasury bonds won't run much further, according to one strategist, who says the effect of technology will keep a firm cap on U.S. interest rates.

After a long period of benign activity, the 10-year Treasury yield ripped higher to around 2.50 percent this week. Yields move inversely to bond prices. The sudden increase was related to talk of increased government debt and higher inflation caused by tax cuts.

Jim McCaughan is the CEO of Principal Global Investors, a company that has $445 billion in assets under management. He said Thursday that the 10-year Treasury yield has now found its ceiling, as interest rates are being capped by tech's deflationary forces.

"Whether its e-commerce driving down prices. Whether it's technology improving the quality of products. Whether its mobile phones doing things that lots of appliances were need to do in the past, everything is being pushed down in cost by the deflationary impact of technology.

"That's keeping the nominal money supply from growing, which is the fundamental driver of interest rates," said McCaughan.

The U.S.-based investor added that the $1.5 trillion Republican Party tax cut passed this week would not push yields higher, as it is to be spread over 10 years.

"With some degree of growth, that actually doesn't take U.S. debt levels out of the sort of comfort zone that governments around the world have achieved in the last few months," he said.

The 10-year Treasury — which is itself reliant on the Federal Reserve's benchmark rate — is key to the U.S. economy because its yield affects the rates of mortgages and other business loans.

And McCaughan did concede that should his fixed income call prove incorrect, any Treasury yield above 3 percent could bring turbulence for market players.

"That might take you out of the pro-cyclical buy-the-dips market that has kept the VIX very low," he added, referring to the CBOE's headline index measuring volatility in U.S. equities.

The asset manager added he saw a 20 percent chance that the current benign environment for investors could suffer a risk event in 2018.

He cited a war in the Korean Peninsula, restrictions to oil supplies and global trade battles as potential problems that could flare up.