We’re in deep trouble. Today, US 10-year government bond yields traded below a critical 2% yield level, a record low. The global bond markets are now signaling stagnating growth, borrowing out of control and unemployment rising.
Since 1997, the Japanese economy has stagnated while yields have never gone above the 2% level.
The graph below shows the history of the yield on the benchmark 10-year US Treasury (UST) and 10-year UK gilt bonds since November 1999, just before the peak of the NASDAQ, to yesterday’s record low yield.
Overlaid is the history of the equivalent benchmark 10-year Japanese Government Bonds (JGB), but this time taken from September 1990, after the Nikkei 225 had peaked. This shows the 10-year JGB yields trending below 2% and then staying there.
This is the error in the orthodox analysis of the economy: to not take into account the portfolio decision on how and in what to invest.
Lower and lower bond yields do not mean continually rising confidence. In fact, at some stage, falling bond yields implies a fast-rising concern about the economic future.
In a large economy, with a deep savings market, where domestic holdings of your debt are above 50%, such as Japan, UK or US, in a situation of a Japan-style stagnation, investors know that if they invest in government bonds they will at least get their money back (even if you monetize it for them).
Very low yields signals a mentality of return of capital, rather than return on capital. For example, today, the UK Debt Management Office sold £4.5 billion 5-year gilts at 1.507% yield.
Never mind the current negative real yield, this is half a percent below the Bank of England’s long term inflation target. Investors are saying that right now, they’d rather lose versus inflation for 5 years than invest in anything else.
A 2% yield signals a complete breakdown in our investment-growth cycle: rather than investing, investors would prefer to lend to the government at 2% for 10 years.
The current swift move by 10-year UST’s to 2% also has some scary read through for the equity market: When 10-year JGB’s went below 2% yields, the Nikkei was 40% off its peak value.
In terms of the FTSE 100, that is equivalent to an index value 2,800. While that is still some way off, we’re 1,000 points closer to it than we were on 7th July.
The bond markets are signaling that on current macro policies, we are facing a Japan-style wasted decade.