Now this is getting ridiculous.
Government bond yields, which were nearly universally forecast to rise this year, have instead fallen with a thud. The result? An apparently calm but inherently unstable market where microscopic yields are forcing investors, from big pension funds to ordinary retirees, to take on more and more risk in pursuit of adequate returns.
The sad math facing global investors was highlighted Wednesday by a further decline in yields on German 10-year government bonds. They now pay a measly 1.1 per cent, their lowest ever. Canadian government 10-year bonds, with a stingy 2.09 per cent yield, are only slightly more generous.
Both countries are examples of a trend sweeping the developed world. From recession-wracked Italy to the relatively robust United States, anyone who wants a safe payout on debt issued by sovereign governments must now sign up for what seems likely to be near zero or even negative returns after accounting for the effect of inflation.
Some will argue this is exactly what central banks want. Ever since the financial crisis, policy makers have tried to encourage investment and spending by forcing down the cost of money. Among their techniques: rock-bottom short-term policy rates, repeated reassurances that interest rates are likely to stay low for a while, and even quantitative easing – a policy of buying truckloads of longer-term bonds to drive up bond prices, which move in the opposite direction to yields.
But it seems unreasonable to blame the plunge in sovereign bond yields over recent months on factors that have been around for years – especially since the U.S. Federal Reserve is on track to end its quantitative easing program later this year and the U.S. economy is finally showing signs of life. Both developments would ordinarily be expected to drive up bond yields.
One factor behind the recent decline in yields is the showdown in Ukraine, which is prodding investors to seek the refuge of safe government debt. The sad state of the European economy, where Italy has slipped back into recession and a dismal report on German factory orders disappointed the market on Wednesday, adds to the case for bonds.
On this side of the Atlantic, the force driving investors to bonds isn't so much a disappointing economy as worries over a stock market that appears to be in frothy territory after five years of big gains. Institutional investors are especially eager to take their profits from the long bull run in stocks and invest in long-term assets that are more stable. Markets are in risk-off mode, according to a note Wednesday from Scotiabank Economics, and investors are scrambling to "sell overvalued equities to buy overvalued bonds."
The question is how long these low, low bond yields are likely to endure. So long as they do, investors have little way to extract a reasonable income from a portfolio unless they venture into risky areas like high-yield debt or those "overvalued equities."
For now, investors seem to be betting on an extended period of abnormally low yields and are willing to commit their money for terms that would once have been regarded as ridiculously long. The Wall Street Journal reported earlier this week on the surge in sales of "ultra-long" sovereign bonds that won't mature for at least 30 years.
In most cases, these bonds, issued by countries that include France, Mexico and the U.K., offer scant protection against any future rise in rates. The government of Canada, for instance, has enjoyed strong demand for its recent issues of 50-year bonds – even though their yield is a less than impressive 2.76 per cent.
The slide in bond yields is eerily reminiscent of Japan, where yields careened lower after a property crash in the early 1990s and have stayed low ever since. Those low yields were accompanied by persistent deflation and low economic growth. But the alternative – a pick-up in economic growth that would send interest rates spiralling higher and crush bond prices – might not be a whole lot more pleasant for investors.