viernes, 6 de julio de 2012

viernes, julio 06, 2012
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The bond market

To strive, to seek, to find, and not to yield
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The remarkable demand for low-yielding government bonds
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Jun 30th 2012
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AMERICA can now borrow from the bond markets at a cheaper rate than at any time in the history of the republic. Germany has raised two-year money for a fraction of a percentage point. Even Britain, a weaker economy than either of those two, is enjoying yields on its ten-year bonds that are at an all-time low.




.The deteriorating state of government finances and their rising debt-to-GDP ratios mean there are lots of these bonds to buy. Nevertheless, thanks to the global economic slowdown and the European debt crisis, the demand from savers for safe assets has overwhelmed the supply. Investors have poured $190 billion into global bond funds this year, according to EPFR Global, a data company, while other funds have seen a net outflow of $1.34 trillion. Almost $1 trillion has gone into bond funds since the start of 2009.
Even negative interest rates do not deter investors. The yield on short-term Treasury bills has occasionally been negative in recent years without affecting demand. Safety is all: this is one of those times when, as they say, it is the return of capital not the return on capital that matters.


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But it is more than just one of those times. There have been crises before, but not even the Great Depression pushed bond yields down this far or this widely. The records being set in the markets are due to a combination of peculiar circumstances, cyclical swings and historical shifts. Together they have produced a bond market which is behaving in a way never seen before.



QE or not QE?

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Look at the factors specific to this particular crisis first. A lot of nervous money is leaving crisis-stricken European nations; €100 billion ($130 billion) left Spain in the first quarter of this year. Investors in these countries are worried about the safety of their local banks, the potential for default on government debt and the risk that the country will leave the euro. To a Greek worried that his savings will lose 40% of their value if they end up in drachmas, a near-zero yield on German government bonds still looks like a good deal.



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Panicky demand is only part of the story. Low bond yields are a deliberate aim of central-bank policies to stimulate the economy at a time when they have already cut interest rates to close to zero.



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In America and Britain, the Federal Reserve and the Bank of England have embraced quantitative easing (QE)—the buying of government bonds with newly created money. The Fed has followed this up with “Operation Twist”, a policy that switches its holdings of short-term debt for long-term debt, with the aim of forcing down yields on the latter.
The Fed has also indicated that it is likely to hold short rates close to zero until late 2014; since bond yields reflect expectations of future short rates, among other things, that promise is likely to have lowered them further.
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The impact of all this central-bank intervention is not clear. The Bank of England estimated that its first round of QE lowered government bond yields by a percentage point. But Treasury bond yields rose during the Fed’s two QE programmes; the declines in yields came in between the two programmes, and between the end of the second programme and the start of Operation Twist (see chart 1).



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The odd behaviour of Treasury yields does not in itself prove that QE was ineffective. It may be, as Jim Reid of Deutsche Bank suggests, that investors believed QE would be good for the economy and therefore switched their money into equities and commodities; both markets rallied sharply during the bond-buying programmes. But it does mean that QE is not the whole story when it comes to low yields—a conclusion reinforced by the low level of German yields in the absence of any central-bank bond-buying.




.Low yields are to be expected in any downturn. When the economic outlook turns grim, government bond prices tend to rise, and thus their yields fall. The reasons are twofold. First, during a recession, inflation, the great enemy of bond investors, mostly stops being a worry. Second, a weak economy leads to more corporate failures and falling profits, prompting investors to flee the equity market.




.In such circumstances, investors’ desire for safety tends to overwhelm concerns about the long-term health of government finances. The Treasury bond is the most liquid asset in the world; investors know that they can instantly sell their holdings without moving the price. This tends to make Treasury bonds the beneficiary of any bad news—even bad news about American government finances. When Standard & Poor’s cut America’s credit rating from AAA in August 2011, Treasury yields dropped.


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The effects of the downturn would not count for so much, though, had it not been for the long-running bull market in bonds that preceded it, a market that brought great returns as it drove yields down.



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Martin Barnes of BCA Research calculates that, since September 1981, the real returns for holders of 30-year Treasury bonds have been an annualised 8.8%. That makes the past few decades one of the two great bond bull markets in history; the other was between mid-1920 and the end of 1940, when annualised returns were 9.2%. In both cases, equities rallied as well, for a time. The 1920s and 1990s are better known as equity bull markets than for their bond returns. But equities eventually faltered (in 1929 and 2000), whereas bond yields drove remorselessly lower (see chart 2).
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But now that bond yields have fallen so far, the road ahead looks barely trafficable. The capital gains that bond investors make as yields fall (and prices rise) are one of the two ways in which they make a return; the other is income from interest. When yields approach zero potential returns peter out; the income is reduced and the scope for further capital gains is limited.



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The thunder and the sunshine



History suggests that investing at the current low level of Treasury yields is a very bad option. Investors who bought Treasury bonds at a 2% yield in 1945 earned a negative real annual return of 2.3% over the following 35 years, according to the Barclays Capital Equity-Gilt study.




There is, though, a prominent counter-example: Japan. Ten-year Japanese bond yields fell below 2% in the late 1990s and have stayed below that level for most of the time since. Hedge funds which bet that Japan’s deteriorating debt-to-GDP ratio would eventually cause its bond yields to soar as the price of bonds dropped have been repeatedly disappointed.



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Generalising from Japan’s experience would be risky. Its debt is owed mostly to its own citizens rather than to foreigners, so it has been saved from the kind of confidence run that has bedevilled Greece and Spain. And Japanese prices have been flat or falling for most of the period, so real bond yields have still been positive.




.In America, Britain and Germany ten-year bond yields under 2% are now lower than the explicit (or implicit) inflation targets of their central banks. Investors are expecting to lose money in real terms. The same phenomenon can be observed in the index-linked government-bond market, where both interest payments and the maturity value are pegged to inflation. Many index-linked bonds in America and Britain are trading on a negative real yield.




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Real yields have been negative before. In the 1970s, investors were caught out by a sudden surge in global inflation, and were too slow to push yields higher in response. But push they eventually did, and by the 1980s yields were high, real rates positive and the scene set for the subsequent bull market. The legend grew of the “bond market vigilantes” who would intimidate governments that pursued loose policies.




.The low real yields of the 1970s were part of a longer period of poor bond returns which can in part be explained by what is known as “financial repression”. Carmen Reinhart of the Peterson Institute for International Economics and Belen Sbrancia of the University of Maryland calculate that average real rates on deposits and Treasury bills were negative throughout the 1945-80 period in advanced economies. They explain this in terms of the policies governments used to escape from the debt burden of the second world war.



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Governments were helped in keeping rates down because of the capital controls they ran as part of the Bretton Woods system of fixed exchange rates. Those kept savings corralled in their domestic market. But there was also regulation that meant pension funds, insurance companies and banks bought government bonds regardless of the yields on offer.




.A similar effect may be occurring today. In response to the crisis of 2008, commercial banks are now required to hold liquidity cushions, usually in the form of government bonds. Regulations are also forcing bonds on insurance companies. In addition, central banks have been lending at low rates to provide liquidity. Banks that have benefited from the European Central Bank’s Long-Term Refinancing Operations have invested some of the money in government bonds. Pension funds once pushed into bonds by regulation are now kept there by demography: retiring members need to be paid their income.



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Help, help, I’m being repressed


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In addition to these domestic enthusiasts, Western governments have also been able to tap overseas savings. Central banks hold government bonds as part of their reserves, with Treasury bonds being by far the most popular asset. Foreigners own 43% of all Treasury debt; official institutions, largely in Asia and in oil-exporting countries, own around $3.5 trillion-worth. These central banks are either just looking for a liquid home for their assets or buying the bonds as a way of managing their country’s exchange rate against the dollar.




.Add together the purchases of global central banks, domestic central banks (via QE) and financially repressed institutions, and well over half of British and American government bonds may be owned by investors who are relatively unconcerned about low yields. Mutual-fund and hedge-fund managers, more bothered about making a decent return, are thus hard put to play the role of vigilantes, so the state of the market is no longer the economic signal that once it was.



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Indeed, in historic terms, conventional wisdom about bond markets has been turned on its head. The gold standard and the Bretton Woods system were both ways of reassuring international creditors that their holdings would not be eroded by inflation or currency devaluations; countries with a sound currency were rewarded with lower borrowing costs. But one reason why British yields are so low today is that investors believe the country has the flexibility to depreciate its currencyunlike the southern European countries which have to choose between austerity and default.



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This division of bond markets into a premier league (of governments that can borrow at less than 2%) and the minor leagues (of those paying 6% or more) is a great advantage to those countries in the former category. America and Britain, in particular, can finance very high deficits (by historic standards) without feeling under pressure. Indeed, despite many years of current-account deficits, both countries have a surplus on their investment-income accounts, largely because foreigners earn such low yields on their dollar and sterling deposits and bonds.



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It is a neat trick: buy real goods and services from other countries and sell them low-yielding pieces of paper in return. And it looks like one that may have a fair bit of mileage left. Investors starved for choice may not relish yield-free bonds. But they seem likely to keep buying them.

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