Hamish McRae: Plunging bonds yield a pointer to troubleComments Off on Hamish McRae: Plunging bonds yield a pointer to trouble
This is going to be a week that will be dominated by politics, not economics.
That will make it harder to hear the messages coming through about the future of our economy, and indeed that of the wider world. We are preoccupied by Brexit, of course, but if you are peering into the UK from the outside, there is one particularly troubling thing to look out for. That is what is happening to long-term interest rates.
To single this out might appear nerdy, for bond yields do not catch the headlines in the same way as, for example, the FTSE 100 index or the sterling-dollar exchange rate.
But something remarkable and disturbing has happened in recent days, and it carries a worrying message about the future of the world economy. It is the plunge in bond yields. They are lower now than they have ever been before — not just lower but massively lower — and they keep on falling.
The implicit message they carry is that there will be another recession in the developed world, and maybe a longer period of very little growth, especially for Europe but maybe also for the rest of the developed world.
Thus German 10-year bonds yield minus 0.13%, Japanese minus 0.26% and Swiss minus 0.58%. These are extreme examples of the so-called flight to quality — “safe” investments that, though you know you will lose money on them, you won’t lose too much. The entire stock of Swiss government debt is now negative, as the world pays money to lend to Switzerland.
The only way this can make any sense at all is that investors expect further appreciation of the Swiss franc against other currencies. The only way those German yields can stack up is if the eurozone breaks up and the German bonds are revalued in the chaos that follows.
That may or may not happen, but there is an impact on the US and Britain too. US 10-year Treasuries are down to 1.45%, and UK gilts to 0.86%, both the lowest ever. They may fall further yet.
From a narrow British point of view, it might seem a relief that — despite all the commotion of the past 10 days — the Government can still borrow at such low rates.
Evidently we remain some sort of safe haven, notwithstanding all the evidence to the contrary — safer on this narrow measure than even the US. This will make the slowdown in the correction of our fiscal deficit cheaper than it otherwise would have been.
It also creates an opportunity to borrow to pay for infrastructural investment, and it will have a knock-on impact on cutting corporate borrowing costs. But a world where investors are prepared to accept lower returns on their funds than at any previous period of human history says something terrible about their outlook for the global economy. The only way investing in bonds at these levels can make sense would be if people expected the obvious alternatives — investing in equities and in property — to plunge.
This is because equities and property are supported by revenue flows — dividends in the former, rents in the latter. If you can get close to a 4% dividend yield from FTSE 100 companies, why on earth invest in gilts?
That is the average yield on the Footsie. The return from some of its largest members is higher — more than 8% on HSBC, nearly 7% from Shell and BP, 5% from GlaxoSmithKline and Vodafone. Maybe those dividends are not secure. But a 4% yield from a selection of the largest companies in the world can’t be bad, and there is the classic protection from inflation that you get from equity investments.
I think we will look back on this period of ultra-low, and in many cases even negative, bond yields as a market madness. We have been here before. It will be analogous to the dot-com bubble at the end of 1999, or those AAA ratings on bundled US home loans in 2007.
But the bond boom can continue for a while yet — and the longer it does, the louder the drumbeat from the markets will become: expect big trouble.
…but Footsie offers a glimmer of hope
The big positive surprise of the past week (and don’t we need a few such surprises?) has been the performance of the FTSE 100 index.
There is the obvious explanation: the majority of companies listed on it are global and have non-sterling revenue streams. In round numbers, between 70% and 80% of total revenues are non-sterling, either in the form of exports from the UK or revenues from overseas subsidiaries.
So the index is not really about the British economy. It is a sterling-denominated bet on the world economy. As the pound has fallen, the natural counter-movement that you would expect to happen would be for the Footsie to rise. The more UK-oriented FTSE 250 market has recovered but by not nearly as much.
This much is clear. But the scale of the FTSE 100 climb is remarkable, and that makes an intriguing counterpoint to the bond madness noted above. Will it continue? In particular, will it continue even if the pound starts to bounce back?
If it does, that says something more positive about the outlook for next year. Maybe the developed world will avoid recession after all.