Ignoring bond markets risky
Few ordinary people around the world really appreciate the significance of the bond market, so suggesting that a profound sea change is about to take place in the market is likely to garner as much excitement as watching paint dry. And yet, in many ways, the bond market rules our lives. American political adviser and key member of Bill Clinton’s first presidential campaign James Carville once remarked: “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”
That was way back in 1993. Carville would be astounded now. The global bond market has more than tripled in size in the past 15 years and now exceeds $100-trillion. That’s a good 40% larger than the total value of global stock markets. The US bond market is roughly twice the size of the country’s stock market.
This development has been driven by one of the most remarkable shifts in global financial history. Over the past 40 years or so there has been an extraordinary, almost unrelenting, bear market in bond yields. At their peak in 1980, an investment in US government bonds, notionally the safest investment on the planet, would earn you a 14% return a year. Now it will earn you 2.5% — if you are lucky. Back then, doubling your money would take less than nine years. Now it will take a little less than a lifetime.
The decline in bond yields was supercharged by the financial crisis in 2008 when central banks rushed out new liquidity, cutting interest rates at huge speed. But the truth is that this was just a blip; the trend was downwards before and after the crisis. The incredible thing is that despite the low levels of return, appetite for government bonds has just got stronger and stronger. Banks, of course, relish cheap money, but that is only part of the story since their gusto ought to be pushing prices up.
Until fairly recently, SA was following this trend. During the emerging-markets crisis in the late 1990s, interest rates shot up at one point to 19% and higher. But then they followed, at more or less the same rate and intensity, the international trend. Recently, with the threat of downgrades lurking, they have backtracked. Nevertheless, bond costs are still half the 1990s average.
The result has been felt most acutely in the property market, which has seen enormous growth. That makes sense because the cost of government debt and the cost of home loans are linked. But it has left governments with huge, huge levels of debt, which currently cost them very little.
All this may be about to change, or at least change somewhat. Recently, US treasuries breached the 2.5% yield level, prompting one of the most prominent bond market specialists to declare that bonds were in bear market. Others disagree, but globally, inflation expectations are rising and central banks are reducing their purchases of long bonds. “It’s a period of quantitative tightening,” quipped one market commentator.
It may be that large changes are unlikely. The social reason for lower bond yields is an ageing global population, since older people are more likely to save than to spend. The most obvious example of this trend is in Japan, where between 1990 and now the proportion of the population over 65 just exploded and is now about 15% of the total population. At the same time, bond yields collapsed, and, even now, very few project bond yields over 2% for the foreseeable future.
But the problem is that the market is now so huge that even small changes could have dramatic effects. The explosion of the housing market has meant the cost of homes might have increased dramatically, but it has also stimulated construction. More important, corporate and government debt has been comparatively easy to service. Marginal projects have been given the go-ahead even though they probably should not have been.
That all could change very rapidly. It requires much more vigilance than it is currently getting.
IT’S A PERIOD OF QUANTITATIVE TIGHTENING, QUIPPED ONE MARKET COMMENTATOR