Here is something to ponder: Last week, the yields on government bonds in Japan, France, Belgium and Austria all hit new record lows.
Yields on 10-year Japanese government bonds plunged to 0.4 per cent, a figure that looks more like a rounding error than the amount supposedly sophisticated lenders seek in compensation for giving title to their money for the next decade to the advanced world’s most heavily indebted sovereign credit.
Yields on government debt also plunged to their lowest levels of the year in Canada, the U.K., and the U.S., where the payout on the 10-year Treasury bond dipped to all of 1.68 per cent.
There are a number of moving parts behind this global, low-interest-rate story. At mid-week, the Bank of Japan unveiled an unexpectedly large anti-deflation program, under which it will buy government debt, sending yields there plunging to almost nothing. This had a domino effect as bond investors scrambled into other markets in the search for anything resembling an interest rate.
In the U.S., Friday’s dismal non-farm jobs gain reinforced a string of recent statistics indicating growth in the United States is slowing, suggesting the Federal Reserve is unlikely to tighten monetary policy any time soon.
Yields this low look like irrational exuberance all over again. Why would anyone be willing to lend to highly indebted governments for years, at puny interest rates, given the risks of inflation?
The smart trade, you would think, would be to bail from bonds, or for those with a speculative bent, to sell bonds short, because the likeliest outcome has got to be a move upward in interest rates. Bond prices move inversely to yields, so if yields do start to rise, prices will drop, causing investors to lose money.
Selling bonds would seem sensible, except for one glaring problem with the thesis. Yields have been falling for more than 30 years. At countless times, it seemed the trend just had to end, only to confound almost everyone by continuing.
If bond bears have consistently gotten it wrong, people like economist and bond bull Lacy Hunt have gotten it right. Mr. Hunt hangs his shingle at Hoisington Investment Management Co. in Texas, a firm that’s been long and right on Treasurys for years, one of the few money managers to play the trade correctly.
Mr. Hunt is convinced bond yields will continue to fall, although the trend will be in fits and starts. He follows the U.S. 30-year Treasury, a bond with a large capital gains potential because of its long remaining life. He expects its yield will drop to 2 per cent “over the next several years.” They’ve recently been trading around 3 per cent.
If the rate reaches his target, it will match levels reached in 1941 that were brought on by the economic malaise of the Great Depression.
The reason Mr. Hunt is bullish on bonds is paradoxical, at first glance. He believes countries are too heavily indebted, having issued too many bonds and borrowed too much, relative to the size of their economies. With consumers and governments tapped out by high debt burdens and needing to pay down what they owe, there just isn’t the fresh, debt-powered demand to drive the economy upward with any vigour.
“What you’ll see in these periods of high indebtedness is you go down to very low interest rates. I mean, look at Japan,” he says.
Once an economy is laden with debt, it’s almost impossible to return to quick growth rates because central banks aren’t able to stimulate private sector loan growth through monetary policy.
He believes the weight of debt will keep economies sluggish for the foreseeable future, until austerity in the form of higher savings rates brings debt down to a more reasonable level.
“The real problem is we have too much debt, too much of the wrong type of debt, and this is a debilitating force,” he said.
Clearing up the debt problem can take decades, over which period rates keep falling. Pointing to Japan, he says its market began its crash way back in 1989, and rates have only now just hit a new low.
Mr. Hunt says the U.S. is only five years into its debt debacle, suggesting to him that there is a long time to go before interest rates reach their ultimate bottom.