60/40 is wounded

The consequences for savers are considerable and talking about the yield on ten-year bonds can obscure the hard reality: yield is income to savers. When we write about forty years of falling yields, we are also writing about forty years of falling income.

High prices, low growth

There are also the implications of high bond prices to contend with.

Firstly, yields to maturity (income plus capital gain or loss as an annual percentage) can be calculated with certainty. And the certainty in some developed markets is that if you buy a bond today and hold it to the end of its term you will lose money in absolute terms. Secondly, an investor can no longer rely on the price of a bond to rise in times of economic distress, to help mitigate the likely losses equities deliver in a downturn.

With bonds now offering very low yields and interest rates close to zero fixed income is unlikely to behave as it has in the past. This is not theoretical. At the start of this year Australian short rates were just 75bps, which investors knew left the Reserve Bank of Australia limited scope to cut rates, capping the upside in bonds. Thus, when pandemic driven panic was driving down equity markets in February and March, the best you can say of the Australian 10-year bond is that it did not lose money, but unlike previous periods of equity market declines this sort of bond was not making money for the investor as she was losing money in equities.

COVID-19 and the downside risk to bonds

Even if the status quo does no more than persist, the outlook for investors in developed market bonds is unattractive and the consequences for portfolios are significant. However, there is a threat to the status quo that makes inflation a credible risk for the first time in decades.

Today we are seeing the largest level of non-wartime fiscal stimulus, nearly ten times as large as in the GFC. Including loan guarantees, the G20 group of nations has provided fiscal stimulus to the end of June equivalent to 13.6% of GDP compared to 1.4% of GDP in March of 2009. Many of these measures have taken the form of direct transfer payments and credit guarantees. These actions are quite different to monetary policy measures and have the power to affect credit creation directly and the velocity of money, in a manner that monetary policy alone does not.