BOND YIELDS HAVE SUPPORT FROM A WORLD GETTING OLDER AND RICHER / THE FINANCIAL TIMES

Bond yields have support from a world getting older and richer

Demographic trends seen subduing inflation and real rates for many years

Robin Wigglesworth



Pensioners tend not to be big spenders, which helps quell inflationary pressures and increases demand for the safety of government bonds © Bloomberg


If Paul Tudor Jones had a choice between holding US government debt or a hot burning coal in his hand, the legendary hedge fund manager would choose the coal. “At least that way I would only lose my hand,” he told clients in his latest investment letter.

He is not alone. The 10-year Treasury yield has climbed from about 2 per cent a year ago to over 2.9 per cent, causing several high-profile investors to declare the end of the 30-year bond bull market. A robust US economy is gaining further stimulus from sweeping tax cuts and an expansionary budget, which some analysts fear will finally ignite inflationary pressures.

Moreover, tax cuts will swell the budget deficit from about 3.9 per cent of gross domestic product last year to about 6.1 per cent in 2020, according to the Congressional Budget Office.

At the same time, the Federal Reserve is trimming its balance sheet, so investors will soon have to absorb $1tn of Treasuries a year.

Nonetheless, there are ferociously strong, longer-term phenomena that are still subduing inflation, interest rates and bond yields. A recent paper by the Bank of Japan offers some useful clues on one of the most under-appreciated factors: demographics.

The world is getting older and richer. That saps economies of their vim and helps quell inflationary pressures — as pensioners tend not to be big spenders — and increases demand for the safety of government bonds.

The paper, written by Nao Sudo and Yasutaka Takizuka in the BoJ’s monetary affairs department, estimates that Japan’s ageing demographics and resulting “savings glut” account for about 2.7 percentage points of the 6.4 percentage points decline in inflation-adjusted interest rates over the past five decades.

The study is a valuable contribution to the swelling body of research on the subject, both because of its exhaustiveness and because Japan is arguably the demographic canary in the coal mine. Although every major country is turning greyer, Japan’s average age is comfortably the highest in the world.

Some analysts have worried that as pensioners grow even older, and start actually drawing down their savings in the twilight of their life, it will reverse the long-term downward pressure on interest rates. Barclays has in the past estimated that this will raise interest rates by about 2.25 percentage points just over the next decade. But the BoJ paper argues those concerns are overdone, primarily due to two factors.

Firstly, the coming demographic changes are much more moderate than the shift of the preceding fifty years. Secondly, the BoJ researchers argue that since the rise in longevity is permanent, it has spurred a permanent change in saving behaviour and therefore interest rates.

They estimate that coming demographic trends will raise rates by less than 1 percentage point by 2060.

Of course, estimating phenomena like “natural” real interest rates — the steady-state level where they neither stimulate nor depress growth — is the economic equivalent of the Higgs boson in physics, a particle that probably exists but can only be vaguely detected from its impact on other more measurable factors.

But markets seem to agree that while bond yields might rise in the short term because of cyclical factors like faster growth, inflation and debt issuance, the longer-term outlook remains largely unchanged. The US 10-year, 10-year forward, essentially what investors think the 10-year Treasury yield will be in a decade’s time, has declined from nearly 8 per cent in the mid-1990s to just over 3 per cent. Inflation swaps and inflation-proofed bonds also indicate that investors think prices will stay muted for a long time to come.

Another new paper, by three academics at New York University, offer up another intriguing argument for why bond yields are so low, and why they will stay subdued for the foreseeable future.

They posit that the financial crisis was such a large shock that it has led to a broad-based reassessment on the likelihood of market calamities. In other words, before the crisis events of such severity were considered nearly impossible, but since then investors have had to embed worst-case scenarios into their risk assessments, leading to more durable demand for the safest government debt.

As Yogi Berra quipped, in theory there is no difference between theory and practice, but in practice there is. Economists might be getting the dangers lurking in bond markets horribly wrong. But for all the current angst, Mr Jones should probably still choose US government debt over a hot piece of coal.