Market’s $20 Trillion Yielding 1% Shows Austerity MistakenAnchalee Worrachate
At a time when politicians are squeezing budgets to cut borrowing, the bond market is clamoring for more debt, pushing yields on almost $20 trillion of government securities to less than 1 percent.
The average yield to maturity for the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index fell to a record-low 1.34 percent last week from 3.28 percent five years ago. Even though the amount of bonds in the index has more than doubled to $23 trillion -- bigger than the gross domestic product of the U.S. and China combined -- countries from Germany to Rwanda sold debt in the past month at their lowest yields.
While Harvard University economists Carmen Reinhart and Kenneth Rogoff say high debt levels slow economies, a warning political leaders from Washington to London have used to justify austerity measures, yields imply investors are giving a green light to boost borrowing. The three-decade rally in bonds shows no sign of abating as gold, the world’s traditional store of value, sinks into a bear market and inflation slows.
“Just like the beginning of last year, 2011, 2010, and 2009, people were convinced government bonds yields are going to head higher, but that hasn’t happened,” Jamie Stuttard, head of international bond management for Boston-based Fidelity Investments, which oversees $1.7 trillion, said in a telephone interview April 23. “Bond yields may stay low, as global growth rates are simply low and central banks’ policy remains accommodative.”
For all the concern that governments are taking on too much debt, there may be a shortage of bonds. Barclays Plc estimates that central banks will buy $2.5 trillion of assets considered to be safe this year as they inject cash into the global economy in an effort to stimulate growth. That’s up from $1.15 trillion of purchases in 2012 and outstrips net supply of $2 trillion, according to the London-based bank.
The global amount of the safest bonds, as measured by ratings companies, will fall to $6 trillion from $10 trillion before the financial crisis, according to an International Monetary Fund report in January. At the same time, the Dodd-Frank financial-overhaul law in the U.S. and regulations set by the Bank for International Settlements in Basel, Switzerland, require banks to hold more top-graded debt as loss reserves.
Bank of America said in a report to clients on April 11 that yields on $20 trillion of global securities were below 1 percent, and that unprecedented stimulus from central banks including interest-rate cuts and asset-purchases was boosting both equities and bonds.
Yields on 10-year Treasuries, the benchmark for everything from corporate bonds to mortgages, were little changed at 1.67 percent at 1:48 p.m. in New York after falling to 1.64 percent on April 23, the lowest this year. The price of the 2 percent note due in February 2023 was at 103.
Low government financing costs are extending to companies and consumers.
Yields on corporate bonds tumbled to 3.15 percent on average on April 25 from almost 5 percent at the start of 2012, the Bank of America Merrill Lynch Global Corporate & High Yield Index shows. That saves about $18.5 million a year on every $1 billion borrowed.
A homeowner in the U.S. taking out a $300,000 mortgage for 30 years would pay a rate of 3.4 percent, down from about 4 percent a year ago, according to Freddie Mac. The interest payment would drop by about $1,222 a year.
“The strong demand for bonds across markets is being driven by a combination of a huge liquidity rush from central banks and slowdown in growth,” Salman Ahmed, a London-based global strategist at Lombard Odier Investment Managers, which oversees $46 billion, said by telephone on April 24.
While the MSCI All-Country World Index of stocks has risen 7.5 percent this year, investors are buying government bonds that the Bank of America index shows returned about 1.7 percent.
The IMF cut its 2013 global growth forecast for a fourth time on April 16, to 3.3 percent from 3.5 percent. A Commerce Department report April 26 showed U.S. GDP grew at a 2.5 percent annual rate in the first quarter, below the 3 percent median estimate in a survey of almost 90 economists by Bloomberg.
Led by the Federal Reserve’s monthly bond purchases of $85 billion, central banks are flooding the world with cash. The Bank of Japan is also printing money to buy debt and the European Central Bank will probably cut its target interest rate this week to 0.5 percent from 0.75 percent, a separate Bloomberg survey shows.
Even the riskiest nations, from Mongolia to Rwanda to the Dominican Republic have found easy money in the bond market.
“Market conditions are very favorable for any credit, let alone frontier places that would be generally perceived as higher risk,” Giulia Pellegrini, a sub-Saharan Africa economist at JPMorgan Chase & Co. in London, said in a telephone interview on April 22.
Mongolia, which raised $1.5 billion in November including 10-year bonds that yielded 5.125 percent, may issue more foreign-currency bonds, central bank Governor Naidansuren Zoljargal said April 18.
Rwanda raised $400 million last week from its debut dollar bond, paying a yield of 6.875 percent on the 10-year securities. Zambia raised $750 million in its first sale of Eurobonds in September, issuing 10-year debt at 5.625 percent. It’s planning an offering of as much as $1 billion this year, Deputy Finance Minister Miles Sampa said April 16.
The Dominican Republic sold $1 billion of 5.875 percent dollar bonds this month that are due in 2024. The nation is rated B+ by Standard & Poor’s and the equivalent B1 by Moody’s Investors Service, both four levels below investment grade.
The Czech Republic, Hungary, Poland and Romania are also paying record-low rates to borrow, as are Mexico and Paraguay.
The flood of sales from lower-rated borrowers may be a signal the bond market has become too frothy.
In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own equities or plan to buy them as falling yields diminish the appeal of fixed-income investments.
Goldman Sachs Group Inc. says investors should own a smaller percentage of government bonds than contained in benchmark indexes. Securities in developed markets are expensive as catalysts for lower rates, such as slower growth in the U.S. and China and the boost provided by the BOJ’s stimulus, may prove temporary, according to the New York-based company.
“The perfect storm that has pushed yields lower is not here to stay,” Goldman Sachs analysts including Francesco Garzarelli, co-head of the firm’s global macro and markets research team, and Silvia Ardagna wrote in a report on April 23. “We therefore continue to recommend being underweight government bonds on both a 3-month and a 12-month horizon.”
Governments may be going too far in their cost-cutting efforts, dragging down growth, particularly in the euro region. Some nations can afford to slow the pace of deficit reduction, IMF Managing Director Christine Lagarde told Sara Eisen in a Bloomberg Television interview on April 18.
“It’s a question of how much and how quickly, and for some of them there’s no reason to rush into up-front, heavily loaded fiscal consolidation,” Lagarde said.
Spain’s 10-year yields dropped six basis points to 4.22 percent today even after the nation said last week it would seek two more years to tackle Europe’s widest budget deficit. That’s down from a euro-era record of 7.75 percent on July 25.
Belgium sold 10-year bonds today at a record low yield of 1.97 percent. France paid 1.94 percent, the least ever, to auction 10-year bonds on April 4. Germany sold 30-year securities at an all-time low yield of 2.16 percent on April 24. Italy’s two-year yields dropped to a record low last week even as the nation struggled to form a new government. Enrico Letta was sworn in as Italy’s prime minister yesterday, ending a two-month political stalemate.
Even with yields so low, lawmakers continue to seek ways to reduce debt levels instead of borrowing to spur growth.
German Chancellor Angela Merkel last week defended her push for spending cuts as an unavoidable measure to overcome Europe’s sovereign debt crisis. In the U.S., as much as $85 billion of spending cuts this year started on March 1 after Congress and President Barack Obama failed to agree on a deal to postpone the automatic reductions.
Harvard professors Rogoff and Reinhart, who argued in a 2010 paper that debt above 90 percent of GDP slowed growth, acknowledged this month they had inadvertently left some data out of their calculations. In response to a paper by three researchers from the University of Massachusetts at Amherst, they said the error didn’t change the basic findings.
The research has been cited by U.S. House Budget Committee Chairman Paul Ryan and European Union Economic and Monetary Affairs Commissioner Olli Rehn in defense of deficit cuts.
Austerity is a “monstrous exercise in unethical human experimentation” Nobel economics laureate Paul Krugman of Princeton University said in an interview with Bloomberg Businessweek on April 11. He favors governments borrowing at record-low interest rates to fund spending programs.
A March 2012 study by University of California at Berkeley economist Bradford DeLong and Lawrence Summers, who was Treasury Secretary under President Bill Clinton, concluded that stimulus may generate so much growth that it would pay for itself.
Key to the debate is a number called the fiscal multiplier, a gauge of how much growth can be generated for each dollar spent by the U.S. government. With short-term rates near zero, DeLong and Summers say the multiplier is at its most powerful.
The U.S. debt-to-GDP ratio will rise to 108.1 percent this year from 98.2 percent in 2010, according to the IMF’s forecast this month. Growth will increase to 2.7 percent next year from 2 percent in 2013, according to more than 75 economist estimates compiled by Bloomberg.
Advocates of stimulus say now is the time to spend because inflation is slowing.
The U.S. core consumer price index, which strips out food and energy prices, rose at a 1.9 percent annual rate in March, the smallest increase since July 2011. A report in Japan last week showed consumer prices, excluding the impact of a sales-tax increase and fresh food costs, tumbled by 0.5 percent in March, the most in two years.
Falling commodity prices are helping to curb inflation. The Standard & Poor’s GSCI Total Return Index of 24 raw materials has declined 8.6 percent from this year’s peak in February. Gold futures dropped by the most in 33 years on April 15 amid concern slowing economic growth in China will damp demand for the metal.
“There seems to be no sign of a let-up in bond demand around the world,” Frances Hudson, a strategist at Standard Life Investments in London, which manages $248 billion, said in an interview on April 23. “I see no prospect of central banks withdrawing their bond-buying programs any time soon. The global recovery is going through a soft patch and inflation is not a concern. This suits the bond market.”