Trends in low places

By Buttonwood

THE longer the chart, the clearer the picture can become.

At the start of 2014, it was hard to find an investor who was bullish on government bonds; economic growth was bound to pick up, central banks would start to normalise monetary policy and yields would head higher. Even now, the latest Bank of America survey of fund managers shows just 5% think government bonds will deliver the best returns over the next 12 months, compared with 63% that plump for equities. But this chart shows a GDP-weighted composite of euro zone bond yields. The trend is inexorably down; even the debt crisis of 2010-12 was barely a blip.

Now of course, extrapolation is always a danger; trends can change. Last night, your blogger took part in a debate about the future of Europe in which one panellist predicted surging inflation, causing investors to lose faith in the euro. But it is very hard to see any sign of that happening. Inflation remains very low; some euro zone countries are in deflation; and the money supply is barely growing (up 2.5% year-on-year).

And it is not too hard to see why bond yields are so low when one looks at the long-term charts (this may be a repeat but it's a goodie).

Nominal and real GDP growth have been on the same remorseless downward trend as bond yields. Some people may be debating whether Europe has turned Japanese but it already has done. There is even the same debate over whether the central bank has been too slow in delivering monetary stimulus and politicians too slow in delivering structural reform. What is the Japanese for schadenfreude?

It may well be that there is little that can be done to stop the rot, given the demography. More QE may well be attempted but as David Owen of Jefferies writes

The economist Richard Koo has done much to highlight the potential ineffectiveness of QE in a balance sheet recession. This ia particularly likely to be the case when nominal GDP growth approaches the zero bound, given the need for nominal GDP growth to help restructure balance sheets, creating the ingredients to help drive recovery. QE may help underpin asset prices, but not feed throuigh to the wider real economy, or if it does the lags involved could be especially long.

Our leader line has shifted to QE with a twist; an infrastructure fund backed by the ECB. But there aren't any easy answers. Investors have been arguing that Japanese bond yields are too low for more than a decade; they have stayed low. The trade is known as "the widowmaker".