Bonds are boring. You buy them for a safe income steady income. Wrong on both counts.
Between 22/6 and 31/8 the price of the Index-linked gilt 2062 went up from 185 to 260! That’s a government bond, not a high tech stock. Some now say with tongue in cheek that you buy equities for income and bonds for capital appreciation – with long nominal bonds touching a yield of 1.1% recently and many equities indicating dividend yields of 4% or so that looks right. But can there really be any prospects for capital appreciation left in the bond market that has been in rally mode since Paul Volcker called “time” on inflation about 35 years ago?
Gilts have performed particularly well this year, outperforming most other government markets as the post Brexit economic pessimism was fuelled by Carney and his latest round of policy stimulus. The fact that QE has done nothing at all to improve the living standards of the majority doesn’t seem to matter to Carney and crew but it seems to be striking a chord with the voters and soon to be voters in the UK and the USA.
Those running UK pension funds are also nursing large headaches as a result of QE. Deficits have been pushed to record levels and company contributions just can’t keep pace with increase in the value of their future liabilities given the collapse in long rates. Pay rise for the workforce? New capital investment? No. No. All surplus cash in the pension fund please. A small rally in the FTSE is of little comfort and don’t even start to think what this does to the bill for the unfunded public sector schemes.
So The People want a change of policy, and there are small signs that it could be on the way. The Monetary policy of the past 20 years and post the great recession in particular has been monetary policy for the rich. For “inflation targeting” read “asset price targeting”. Markets must not fall!
Central Bankers have too much invested ego to confess to any shortcomings and politicians will probably be wary of meddling with the current frameworks, for now, but more coordinated policies with more emphasis on fiscal expansion seem likely in many countries. So we can stop pretending that we have been practicing austerity and turn on the fiscal gas. The taboo around breaching the 90% debt to GDP will be broken (In the UK). Borrowing costs are close to zero so its practically free money and I need to get re-elected the politicians are thinking. There is accumulating evidence that the UK, Japan and the USA could head in this direction.
In recent weeks markets have started to sense a potential change of this kind and in the UK and Japan bond yields have backed up somewhat. There is a pushback against central banks extending the experiment of negative interest rates. Bondholders however don’t want to hear central bankers say “we are done, we are out of bullets” – they will run for the hills.
But it’s probably a bit too soon to expect central bankers to move into passive mode. Increasing the targeted level of inflation, helicopter money and cancelling the government bonds held by central banks will probably all be considered.
Whatever exact form policies take in the coming years one conclusion seems appropriate. These policies will not be designed to protect the owners of financial assets if indeed it is possible to design any policy that offers protection when your starting interest rate, or discount rate, is practically zero.