Why are bond yields so low?
When I started my career over thirty years ago, Australian ten year Government bonds offered a yield of around 14% and global bond yields were similarly high. The big question then was why they were so high? Now, it is why are they so low? The ten year bond yield in Australia is just 2.6%.
> Long term they won’t be sustainable at these levels, but given the historic experience after past periods of falling yields they could linger for a while.
> Super low bond yields imply a low medium-term return potential from government bonds. There are better opportunities in other higher yielding assets.
When I started my career over thirty years ago, Australian ten year Government bonds offered a yield of around 14% and global bond yields were similarly high. The big question then was why they were so high? Now, it is why are they so low? The ten year bond yield in Australia is just 2.6%. In the US its 2%, Spain 1.6%, Germany and Japan just 0.4% and in Switzerland it’s actually -0.04%. (Yes in Switzerland you pay the Government to lend them money – as the Swiss central bank has set short term interest rates even more negative). This is an important issue because if you buy these bonds and hold them to maturity those yields are the annual returns you will get! This note looks at why bond yields are so low, whether it’s ultimately sustainable and what it means for investors.
Source: Global Fianacial Data, AMP Capital
How bonds work
But first it’s worth a reminder as to how bonds provide returns. Like most investments, bonds have a price and a yield, but most commentary occurs in terms of the yield. If the government issues a bond for $100 and agrees to pay $4 a year in interest, this means an initial yield of 4%. Obviously the higher the yield the better in terms of return potential, but in the short term the value of the bond will move inversely to the yield. So if growth or inflation slows and interest rates fall investors might snap up bonds paying 4% till the yield is pushed down to say 3%. In the process the value of the bond goes up giving a capital gain for investors. This is what’s happened lately. But, if growth and inflation pick up and bond yields rise, investors suffer a capital loss. And if for the remainder of the life of the bond the yield remains 3% that will be the return, ie 3% pa.
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