Are US and UK sovereign bonds in a bubble? With the US ten-year Treasuries yielding a mere 1.45% and UK ten-year gilts on 1.49%, the obvious answer – and the one we usually give – is yes.
Their prices, thanks to a mixture of safe haven demand, non-stop quantitative easing (via which all excess supply is hoovered up by central banks) and financial repression, are far too high, and will at some point fall fast. That might not happen this year or next year, but it will happen. The ropey finances of the two countries makes it all but a given.
However, there is a another way of looking at this. What if bond yields have simply reverted to the mean (as most things do) and have seen a temporary over shoot? Paul Hodges of International eChem has drawn my attention to the chart below (it is based on data from the annual Barclays Equity Gilt Study).
What it shows us is that UK yields (blue) averaged 3.7% from 1900 to 1949 and have averaged 4.2% since 2000. Similarly, US yields averaged 2.7% between 1926 and 49 (no records before that) and 4.5% since 2000. “This would suggest it was the peak in the middle, between the 1970s-90s – when yields averaged more like 8-10% – that was the exception rather than the rule,” says Paul.
Paul has an explanation for this. It is, he says, all about the fact that the baby boomer super-cycle is over. I’ve looked at the effect that might have on growth in the past here: Bad news for growth: the baby-boomer super-cycle is over. But the point here is that the baby boomer rush for pension and retirement safety is another factor pushing bond prices up (and yields down).
It’s a nice idea, and there is probably a good deal of truth in the idea that falling yields are in part connected to demography. However, it doesn’t really change our current view about sovereign bonds.
Even if you assume the huge fall in yields from the highs of the 70s and 80s have had an element of mean reversion in them, and that they should be knocking around 3% – at well under 2% they have clearly gone too far in the other direction for long term investors to feel safe holding them.
Look at some more of the data from the Equity Gilt Study and you will see that investors who bought gilts at their last peak (in 1946) did not break even on their investment in real terms for 47 years. More on this here.