Business Week recently ran a story with some astonishing facts about bond issuance and interest rates around the world, Bonds, Bonds Everywhere and Not a Drop to Yield.
A few of those facts:
“The average yield to maturity for the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index fell to a record low 1.34 percent last week, compared to 3.28 percent five years ago.”
“Indeed, corporate bond yields fell to 3.15 percent on average on April 25, from almost 5 percent at the start of 2012, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index.”
Unthinkable back in the depths of the financial crisis of 2008/2009 where high yield bonds were yielding double digits and you could get over 5% in a muni money market (this was a short term quirk).
Interest rates have steadily fallen since their peak in 1981. Some US Government bonds actually trade with negative yields (they are inflation-protected).
This must be the end though, right? Interest rates surely can’t fall any further and they have to go up soon, right?
I’ve listened to the prognosticators predict higher rates now for almost four years…and rates instead went lower. Are interest rates going to turn around and go up anytime soon? I doubt it.
I decided to do some digging on rates in the United States (and for the fun of it, Japan) to give you an idea of the possibilities. This is not a prediction, I just want to demonstrate that something which is said cannot happen…has happened before.
In 1933 the one year rate on a government issued bond went below 2%.
In 1941 the one year rate on a government issued bond hit its low, .53%.
In 1951 the one year rate on a government issued bond finally broke back above the 2% mark hitting 2.12%, in 1952 it hit 2.39% and in 1953 it was 2.58%. The rate then dropped below 2% again in 1954 for two years before finally climbing above 2% in 1956 (3.21%) and not looking back until 2009.
For 23 years interest rates were essentially 2% or below stretching from 1933 – 1956.
But that is for 1 year rates, what about longer term rates. I use the 3% level for the ten year, though currently our ten year is under 2%.
The ten year rate on government issued bonds fell below 3% for the first time in 1935, but keep in mind it had been in the 3% range for ten years prior. The rate proceeded to stay under 3% for 22 years straight. From 1935 – 1956 the ten year rate remained under 3% and from 1925 – 1963 the rate remained under 4% with the exception of just a few years.
For comparison, we are in our 5th year of sub-2% one-year yields and only in our 2nd straight year of sub 3% ten-year yields. We did have a three year stretch between 2002 and 2004 of sub 2% one-year yields and the ten-year has been below the 4% level since 2008.
In Japan, the benchmark interest (the discount rate) will have been below 2% for twenty-years come this September.
This is not an exhaustive study of interest rates, nor is it my prediction of what interest rates are going to do. This is a refutation of what many market prognosticators state MUST happen soon. Rates may rise soon, I doubt it, but they DO NOT have to rise.
Again, this is not an opinion about the lower interest rate policy.
While I was writing this post, Cullen Roche over at the Pragmatic Capitalist blog posted an interview by Lance Roberts with Doubline CEO Jeffrey Gundlach. Gundlach, along with Bill Gross and Daniel Fuss (some would also say Kathleen Gafney) are the current bond guru’s (this means they’ve achieved great returns trading bonds in the past, whether they were skilled or lucky is a different observation). Gundlach does make predictions on rates and I thought his comments were intriguing, as follows:
“Let me reiterate….bond yields are not going to rise. QE drives yields lower as it goes straight to the heart of the bond market.”
Rates will not rise with real HIGH unemployment. The unemployment (U-3) rates is a false measure of employment due to the high level of dropouts. All that really matters for the economy, and ultimately the bond market, is the labor force participation rate which is at the lowest level since the 80’s.
Rates will not rise with median household incomes at the lowest level in 19 years.
Rates will not rise as QE is all about funding the federal budget. if rates rise the budget will be blown and deficits will explode.
Rates will not rise as it will kill any economic growth. Housing, private investment and consumer borrowing all rely on low interest rates. If rates rise it is the end game for the economy.
Despite what you may have heard – the reality is that rates will not rise any time soon. This is the liquidity trap the Fed has gotten itself into.
Furthermore, Bond indexing makes no sense into today’s market. However, emerging market bonds, on a very selective basis, will likely be lucrative as the global economic malaise continues in their developed counterparts.
If the current financial experiment fails – the only place to be will be long US Treasuries. A decent hedge in the event of an economic disruption will be long US Treasuries and short French Bonds. As all European bonds converge toward 1% the reversion due to economic disruption could be hugely profitable.
Own bonds? You bet. With corporate profits in the U.S. at all-time highs as a percent of GDP the repayment probability for bond holders is extremely high. However, this is also bad for holders of corporate stocks because the reversion of profits to GDP will be brutal.
I could go out and find you all sorts of quotes from other money managers who think the opposite, but that is the mainstream view – so it’s boring.
Just remember, when someone tells you that rates can’t stay this low for much longer, they haven’t done much historical analysis. Heck, I spent less than an hour finding the little bit of information above. The information was provided by Robert Shiller’s data project.
This post is already to long, but for another great article loosely related to this topic, see Business Week’s The “Rising Bubble in Bond Bubble Chatter.”
Scott Dauenhauer CFP, MSFP, AIF