The Federal Reserve has tipped a wink to bond investors that interest rates in the USA will be pegged close to zero until at least the end of 2015, whatever the result of the upcoming Presidential elections in November.
Treasury bonds are showing slightly higher yields – the 10-year note was 1/32 higher at 1.678%, while the 30-year bond was 9/32 higher to 2.828%.
Generally, markets find the low yields on government bonds one of the ost striking features of the current global economic cycle.
Ian Stewart, Deloitte’s Chief Economist in the UK, has pointed out that yields on 10 year bonds issued by the UK government are at the lowest level in more than 300 years – since 1703.
Borrowing costs are low
“Over the summer yields on German and Swiss two year bonds turned negative, creating the remarkable situation in which investors are paying for the privilege of lending money to governments,” said Stewart.
Not all countries can borrow at low rates either – despite pledged intervention by the European Central Bank of unlimited bond buying, the cost of borrowing for 10 years for the Greece government is more than 10 times what Germany pays.
“Countries in the northern euro area, and pretty much all industrialised countries elsewhere, the cost of borrowing for the government is exceptionally low,” said Stewart.
He reckons four factors are at work:
- Demand for safe assets is rising. Investors will pay a premium to hedge against the risk of declines in the value of their capital. Stewart reckons that’s why UK investors buy government bonds despite interest rates failing to keep up with inflation for four years.
- Declining growth expectations signify lower returns on risky assets like equities. This process has supported demand for government bonds and, in turn, reduced yields, explains Stewart.
- Government bonds offer protection against deflation as investors are assured of getting their money back from bonds
- Quantitative easing and tighter regulation designed to strengthen the financial sector has led banks to increase their holdings of government bonds.
Bonds seem bad for investors
“It would be complacent to say that the cost of borrowing is unaffected by levels of government debt,” said Stewart. “Yet in an uncertain world, where growth and inflation are expected to run at low levels, government debt seems, for many investors, to be the least-worst place to put their money.
“Some commentators argue that we are experiencing an unsustainable bubble in governments. Certainly bond prices have risen at a remarkable rate in recent years. Whether an asset price boom is sustainable depends on whether the fundamentals of the economy have changed. If we are in a new normal world of elevated risk, weak growth and low inflation, current ultra low bond yields may be here to stay. If not, bonds are heading for a fall.”