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The Impact of Falling Bond Yields

September 8th, 2016 by

percent-interest-taxesAs bond yields continue to plunge to historical lows, investors are getting fleeced. The more that uncertainty, fear, and uneven economic growth drive investment into the bond market, the more potential income is being forfeited.

According to a report released on Wednesday by the ratings agency Fitch, “global investors are forgoing over $500 billion in annual income” due to the bond rally—a half-trillion dollars annually!

Falling Yields

Due to the inverse relationship between bond yields and bond prices, the ultra-low yields on government debt means that bond prices are at historical highs. This means that recently-purchased bonds in the average investor’s portfolio are outperforming. The real danger is for institutional investors and pension funds that make large-scale investments and rely upon the income from bond yields.

Source: Fitch Ratings via MarketWatch

Investors who are buying bonds now would obviously prefer that yields go up. (However, falling yields and all-time low yields still haven’t deterred demand for bonds.) Someone who is already holding a portfolio of more mature bonds, like pension funds, are being hammered by the falling rates. This is how the shortfall of $500 billion is calculated when compared to bond yields five years ago.

On the $38 trillion in outstanding bonds, some $36 billion in income has been wiped out by the drop in U.S. Treasury yields, while another staggering $95 billion of lost income can be accounted to the drop in yield on Japanese sovereign bonds. The situation is much the same in the U.K., Italy, Spain, Germany, and China.

(It’s worth noting that the 10-year T-note yield is up over 4% in trading today to 1.61% while the comparable Japanese 10-year bond has gained better than 36%—but remains in negative territory at -0.04%!)

Looking Forward

looking-aheadThis situation is very likely here to stay for a relatively long time, unfortunately. The global markets are not simply going to enjoy a swift reversal given the current interest-rate environment. Moreover, central banks have a vested interest in continuing to prop up the stock markets by making borrowing exceptionally easy.

What’s good for equities in this arrangement, however, is likely anathema to big funds that are heavily invested in government debt. In the same report cited earlier, Fitch points out that if “rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.”

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.