Negative Yields and Low Growth

About 20% of all global government debt has negative yields. This means that buyers who hold to maturity LOSE nominal dollars, and lose even more in real terms, since inflation is still positive in most areas of the world. This is the new normal, and it is about to get much worse.

Yields everywhere are dropping to record lows. What is driving this and what are the consequences?

Drivers and consequences

Government bond yields are proxies for inflation and inflation expectations, as well as future growth projections... and… monetary interventions, as Central Banks can “print money” free of charge (the image would be that they go on the computer and type “+1000 billion dollars” and there you go) and they buy bonds galore with that printed money, which boosts prices and decreases yields (prices and yields go in opposite direction). This boosts prices in other markets, from stocks to corporate bonds to housing and land.

Another structural driver of low yields is global central bank liquidity and global savings, both of which have increased a LOT in the past decade. Due to growth in emerging markets, people have more savings and that savings adds to the stock of central bank money, all are funds looking to “park somewhere”, which increases asset demand and asset prices. Income and wealth inequality also drive asset prices higher (and yields lower) because most of the income growth in large and rich economies has been going to the top 1%, who are of course mega “savers”: give a million dollars to a person earning 10 million per year and worth upward of 10 million, and it is likely that this person has no “need” for this money, thus he/she saves it all: it goes to asset purchases, driving asset prices higher still…

Inflation is low and not menacing, global savings is high, global central bank liquidity is high… all this favours asset demand, hence high asset prices and low yields.

Add to this technology and aging demographics in industrialized countries and you get MORE downward pressure on inflation and yield (interest rates)… this all explains why rates are super low and are not about to go higher.

Furthermore, inflation is created via debt creation. For debt creation to build enough, you need some “part” of the economy to load up on debt: households, corporations, and/or the State. None of these are now piling on extra debt, as they are all already high in debt OR refusing to take on debt for fear of too much debt to carry. This all means there is little extra debt creation, hence low inflation and low yields.

The last part is that growth is slowing in most industrialized economies due to demographics and other structural forces.

Real GDP growth (year-on year annual growth rate) for the USA, which shows the gradual downward shift seen in almost all other rich countries:

All this means low yields, low inflation, low interest rates, low growth, low fiscal income, and low unemployment.

Central banks trying to boost inflation to their 2% target may find it impossible to do so, as they push on a string: you can print all the money you want, but if there is no extra debt created to absorb it, that money just floats around in asset markets and creates “asset price inflation” instead of good ol’ CPI inflation.

Now that there seems to be at least a global “slowdown” / mini recession on the horizon, more funds are funneling to already-low-yielding bonds, thus pushing prices higher and yields lower… many into sub-zero territory.

Sub-zero yields are great for mortgage holders and all that, but they can kill the meagre returns you can get on savings. This pushes people into more risk-taking to get some yield, thus making the whole thing fragile to shocks.

Risks?

This party can continue as long as yields don’t rise and there is no monetary tightening (which is the typical cause of rising yields)… what can cause yields to increase?

1. Inflation.
2. Dramatic events.

For now, none of these 2 seem likely, so the party will go on. If one of these 2 emerges, then it could get extremely ugly extremely fast, as the entire logic would go in the other direction: massive global selloff of anything risky, etc. We are not there, so it’s all good. If inflation rises convincingly by some miracle, then watch out. As I have explained in other posts, absent very major and rare political or policy events that really shake confidence, no inflation = no problem! Clap and share. Pascal Bedard.