Accentuate the negative
A very unusual sign of confidence in economic policy
Nov 4th 2010
WHAT is the point of investing? For most people the aim is to earn a return that is at least higher than inflation. If you can’t achieve that, you may as well spend your money straight away.
So it seems rather odd, at least on the surface, that the American government was able to sell inflation-linked bonds last month on a negative real yield. Those who bought the bonds were guaranteeing that their investment would lose purchasing power. Why on earth would investors—presumably sane ones—do that?
There have been previous examples of investors earning negative real yields on conventional government bonds, particularly in the 1970s. But they have usually been attributed to a failure to anticipate an inflationary surge, rather than the result of a deliberate decision.
This time round, however, negative real yields arguably reflect optimism that the Federal Reserve, via the policy of quantitative easing, can deliver a good economic outcome and avoid the extremes of deflation or hyperinflation. The bond issue is also good news for the American government. There is no sign yet that investors are panicking over the size of the fiscal deficit or the lack of any medium-term austerity plan.
Inflation-linked bonds promise that both the coupon (interest payment) and the redemption value will keep pace with prices. Take a bond with a 2% real yield maturing in ten years’ time; the bond will pay an initial $20 on a face value of $1,000. If prices double over the decade, it will end up paying $40 on a maturity value of $2,000. The latest bond had a five-year maturity and a yield of 0.5%. Investors bought the issue at 105% of par, locking in a yield of 0.55% below inflation.
The best way of looking at these bonds is that investors trade inflation protection for a lower starting yield. The difference between conventional and index-linked bond yields of the same maturity is roughly equal to expected inflation.
The negative yield on inflation-linked bonds is just a corollary of the very low yields on conventional debt. If five-year Treasury bonds are yielding 1.25%, as they were on November 2nd, then a negative 0.55% real yield on inflation-linked bonds implies an expected inflation rate of 1.8%. This suggests that the Fed has been successful at forcing inflation expectations modestly higher. In late 2008, after the collapse of Lehman Brothers, the market was pricing in deflation (see chart).
The easy-money policy of the Fed explains why inflation-linked bonds may not be a bad deal for investors. Mark Capleton of Société Générale says yields reflect the expectation that the Fed will hold short-term rates below inflation for the foreseeable future. If inflation averages 1.5% over the next two years, and the Fed keeps short rates at 0.5% or less, then the real yield on cash will be -1%. In that light, a negative yield of 0.55% on index-linked bonds seems a good investment. Short-dated conventional bonds have such low yields (the two-year Treasury pays just 0.34%) that investors in them are almost certain to lose money in real terms, too. And buyers of index-linked bonds have protection against deflation, since they will always be redeemed at their face value or higher.
This situation is not unique to America. The British inflation-linked gilt that is due to mature in 2016 trades on a negative real yield. Even long-dated yields are less than 1% in real terms, thanks to demand from pension funds.
Are these low real yields a sign that investors are desperate to protect themselves against inflation? Some believe that quantitative easing is setting the economy up for an inflationary surge in the long term. Bill Gross of PIMCO, a fund-management group, wrote recently that: “Cheque-writing in the trillions is not a bondholder’s friend; it is in fact inflationary and, if truth be told, somewhat of a Ponzi scheme.”
But there is little sign that other bond-market investors agree with him. If you compare the yield on conventional bonds with the yield on the index-linked Treasury bond that matures in 2028, the result is an implied inflation rate of 2.4%. That hardly sounds like the Weimar Republic.
So why is gold, a classic anti-inflation hedge, still doing so well? The answer to this enduring puzzle may lie in the level of real interest rates. As Chris Watling of Longview Economics points out, gold’s last great bull run was in the 1970s, when real yields were negative. Positive real rates in the 1980s and 1990s had bullion trading sideways for 20 years. In a world of negative yields, owning gold has no opportunity cost.
0 comments:
Publicar un comentario