Ask not when interest rates will rise.
The real question for investors and savers is how low they can go. Government bond yields have fallen sharply since the surprise referendum vote in Britain to exit the European Union. Bond prices move in the opposite direction of yields, so the flood of money into the safe haven of bonds lately has both pushed up prices and depressed yields. The 10-year Government of Canada and U.S. Treasury bonds have recently hit all-time lows, in fact.
Here are three things this drop in bond yields tells us about the state of the financial world today:
1.) Investing pros are petrified: Financial markets despise a surprise, which the Brexit vote was. Rattled, they are looking for safe places to put money and they're not too worried about making a decent return. The yield on 10-year Canada bonds fell below 1 per cent in trading on Tuesday. Think about it – a 10-year loan to the federal government for less than 1 per cent a year. If you think that's bad, investors are also buying bonds issued by the governments of countries, like Switzerland, with negative yields. In other words, bond holders are essentially paying to hold these bonds.
2.) We'll have low rates for longer: You can read the flow of money into bonds maturing in 10 year and more as a bet that the outlook for rates is either declining or stable at today's historic lows. The message here for investors and savers is that there will no opportunity to boost returns with higher rates any time soon, and that even lower rates are a risk. There is more onus than ever to find the best rates on savings accounts and make smart decisions in building diversified portfolios.
3.) Bonds aren't a dead asset class after all: Low bond yields mean less of a role for bonds in a portfolio, right? Actually, no. First off, the point of bonds is to act as a hedge against economic upset and stock market declines. Bonds have done this admirably since the Brexit vote. Second, declining yields are driving some decent total returns for people holding bond and bond funds. Total returns are the change in price plus the yield from interest payments. If rates go lower, bonds have more to give.
Rob Carrick