August 18, 2016

Bond Yields that Defy Logic

The yield on global investment grade bonds has recently touched an all-time low of 1.1%, with over 30% of the world’s government bonds paradoxically trading at yields below zero.1

bonds

If you were focused only on past returns, this might not trouble you, because lower bond yields correspond to higher bond prices and higher account balances. But for a forward-looking investor who is focused on future return potential, record low market yields are unwelcome news, because they set an expectation of very low future returns.

Consider the example cited by The Wall Street Journal on August 11 regarding recently-issued negative-yielding German zero-coupon bonds:

“A buy-and-hold investor is guaranteed to lose money, even before taking inflation into account. The only way to make money is to find another buyer willing to pay a higher price – but that implies a bigger loss down the road.”

This is an unprecedented time in global markets and the current environment is largely attributable to Central Banks’ coordinated efforts to stoke growth and inflation. In the end, the message to investors is clear: Either passively accept lower future bond market returns (along with greater price risk), or consider other ideas such as saving more, spending less, or examining alternatives to bonds.

 

(1) Global investment-grade bond yield is based on BC Global Aggregate Index. A bond is considered investment grade if its credit rating is BBB- or higher by Standard & Poor’s or Baa3 or higher by Moody’s.