How low can bond yields go?

In 2010 bond guru Bill Gross warned investors that UK gilts were “resting on a bed of nitroglycerine”. Yet prices just kept rising (and yields falling). Since 2010 the yield on ten-year British government paper has slid from 4% to a new record low around 1.15%, and our public debt has risen by another £600bn. So if gilts were on a bed of nitroglycerine ten years ago, says Moneyweek contributor Tim Price in his PFP Wealth Management newsletter, today “they are bouncing up and down, in spiked running shoes, on a bed of picric acid… while firing flaming napalm arrows”.

The bond bubble has just kept inflating. This week, yields touched new all-time lows all over the world. Japan’s ten-year yield hit -0.185%. Germany’s ten-year Bund yielded a negative amount for
the first time. More than $10trn of global sovereign debt is yielding less than zero. So if you buy and hold these securities until maturity, you are paying a government to look after your money, and you will get back less than you invested.

Nobody buys bonds at these levels “thinking they are attractive”, as Jussi Hiljanen of Nordic bank SEB told Many investors appear so rattled by the prospect of a Japan-style deflationary slump that they are betting on a positive real yield if prices slip below zero. Or they are holding them in the expectation of selling them on once the price has risen more – the “greater fool” approach.

You can see why they might think like that. As Bank of America Merrill Lynch points out, central banks have cut interest rates 654 times to record lows since Lehman Brothers collapsed. They have bought $12.2trn of assets, mostly bonds, with printed money – a third more than China’s GDP.

Yet for all that, the debt-burdened world recovery remains lacklustre and vulnerable to reversals. And “markets… have gone through the looking glass”, as the FT’s Katie Martin says. We’ve reached the stage where central-bank activism and negative yields are starting to do more harm than good, says Hamish McRae in the Evening Standard. They damage bank profits and hence confidence within the banking system. Pension funds can’t offer savers a return. All this, along with slow growth, is undermining business and investor confidence.

How much longer all this can endure nobody knows. Given that Bill Gross opined this week that bonds were a supernova that “will explode one day”, the answer may be “quite a long time”. But the downside if and when inflation makes a comeback is huge, and growing bigger every day. Stay away.