{"id":2760,"date":"2020-01-20T21:22:14","date_gmt":"2020-01-20T21:22:14","guid":{"rendered":"https:\/\/maxrezmedia.com\/website_131ddb8a\/?p=2760"},"modified":"2024-08-16T21:51:49","modified_gmt":"2024-08-16T21:51:49","slug":"government-bond-yields-and-returns-in-the-2020s","status":"publish","type":"post","link":"https:\/\/maxrezmedia.com\/website_131ddb8a\/government-bond-yields-and-returns-in-the-2020s\/","title":{"rendered":"Government Bond Yields and Returns in the 2020s"},"content":{"rendered":"

Bryan Taylor, Chief Economist, Finaeon<\/p>\n

\"\"<\/p>\n

The 2020s have begun. \u00a0During the 2010s, the fixed-income market has done things no one would have predicted when the 2010s began ten years ago.\u00a0 The most important feature of the past decade has been the steady decline in government bond yields, falling to negative nominal yields in most of Europe and negative real yields in the United States and Canada.<\/p>\n

Government bond yields have been declining since 1981 throughout the world.\u00a0 In the United States, the 10-year bond yield was 3.85% at the end of 2009, but has declined to under 1.90% today. \u00a0The yield on 10-year government bonds in Japan has declined from 1.30% in 2009 to -0.06% in 2019 while German bond yields have declined from 3.37% to -0.30%.\u00a0 Across the world, interest rates are negative in real terms.\u00a0 In Switzerland, even the 50-year bond has a negative return.<\/p>\n

I believe that interest rates cannot continue to decline.\u00a0\u00a0Why accept a negative return when you can always hold cash with a zero return?<\/em>\u00a0 There are transaction costs of buying and selling bonds.\u00a0 Although these costs can be easily factored into a long-term bond, this is more difficult with a short-term bond.\u00a0 Will the 38-year bull market in bonds driven by declining yields come to an end? Is a new multi-decade pattern of rising bond yields replacing the declining yields of the past few decades?\u00a0 There are over $10 trillion in outstanding government bonds with negative yields in the world.\u00a0 Many of these bonds are owned by governments so the yield is almost irrelevant.\u00a0 Will bond yields still be negative ten years from now?\u00a0 Will interest rates decline or rise during the decade to come?<\/p>\n

The Interest Rate Pyramid<\/strong><\/span><\/h3>\n

We are currently in a 75-year cycle of rising and falling interest rates. The government controlled interest rates during World War II to limit the government\u2019s cost of funding the debt it issued to pay for the war.\u00a0 When the war was over, the government allowed the market to once again determine bond yields, and the government\u2019s policies fed inflation driving prices and bond yields up between 1945 and 1981.\u00a0 Paul Volker decided to fight inflation at any cost and reversed the pattern of rising inflation and interest rates.\u00a0 Inflation and bond yields have declined since 1981 falling from 15.81% in 1981 to under 2% today.<\/p>\n

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Figure 1.\u00a0 United States 10-year Government Bond Yield and Return, 1919 to 2019<\/strong><\/span><\/p>\n

Fixed-income investors are concerned about two factors, the capital gain or loss they receive when there is a change in the bond yield and the interest payments they receive each six months from the government.\u00a0 GFD\u2019s 10-year Total Return Government Bond index takes both of these factors into consideration in calculating the total return to holders of government bonds.\u00a0 During the period of rising interest rates between 1945 and 1981, bondholders received higher interest payments over time, but lost money as higher interest rates drove the price of bonds down.\u00a0 The opposite effect has occurred since 1981.<\/p>\n

What is interesting is that the capital gain\/loss that occurs because of rising or falling bond yields offsets the interest bondholders receive to even out the return to investors. The assumption is that as the bondholder receives interest payments over time, this money is reinvested in government bonds at the current yield in the market. In theory, the bondholder could completely reinvest his principal and interest in a new bond each year. Bondholders can also invest in mutual funds that effectively do this for them.\u00a0 The interesting thing is that over the past 75 years, the capital gain\/loss that has been generated by the rising and falling bond yields has offset the rising and falling coupons that have occurred over time.<\/p>\n

Figure 1 compares the yield on the US 10-year bond in black with the total return to an index of bonds invested in 10-year government bonds in green.\u00a0 The return index compares the return to government bond holders between 2008 and 2018 with the yield to government bonds in 2008.\u00a0 Of course, you would have needed to wait until 2018 to find out what the return was to investors in government bonds in 2008, but as Figure 1 shows, the correlation between the yield on government bonds at any point in time and the actual return investors receive over the next ten years is uncanny.\u00a0 The fact that this pattern has persisted for the past 100 years is amazing.<\/p>\n

Examining other countries, you get similar results. Figure 2 shows the relationship between bond yields and returns for Japan and Figure 3 shows the relationship for France. \u00a0The relationship between bond yields and returns is not always as strong as it is in the United States, but the general relationship still exists.<\/p>\n

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Figure 2.\u00a0 Japan 10-year Government Bond Yield and Return, 1919 to 2019<\/strong><\/span><\/p>\n

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Figure 3.\u00a0 France 10-year Government Bond Yield and Return, 1919 to 2019<\/strong><\/span><\/p>\n

The Decade to Come<\/strong><\/span><\/h3>\n

Examination of global bond yields in Figure 4 compares bond yields over the past 20 years in the United States, Germany, the United Kingdom, Japan, Canada, Australia and Switzerland.\u00a0 Interest rates in Germany, Japan and Switzerland have turned negative, and after adjusting for inflation, you would find that real yields in the remaining countries are negative.<\/p>\n

If you look at the yield and return graphs for the United States, Japan and France in Figures 1, 2 and 3, you will see that the returns are not provided after 2009 because we don\u2019t know what the behavior of bonds in the 2020s will be and thus cannot calculate the total return to bondholders between 2012 and 2022, for example, because this number will not be known until 2022.<\/p>\n

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Figure 4.\u00a0 10-Year Government Bond Yields for Seven Countries, 2000 to 2019<\/strong><\/span><\/p>\n

The inevitable logic that would come from this analysis so far is that if the yield on government bonds declined in the 2010s as they did in the 1980s, 1990s and 2000s, then a continued decline in government bond yields during the next decade is the most logical outcome.\u00a0 If bond yields were to rise, this would impose capital losses on bondholders, driving the total return to negative levels even below the yields that persisted in the 2010s.<\/p>\n

To illustrate this fact, I have calculated what the total return to US government bondholders would be if bond yields rose by 0.125% in each of the next ten years and if they fell by 0.125% annually starting at a yield of 2% at the end of 2019.\u00a0 With these assumptions, I can calculate both the return from interest payments and the impact on the price of government bonds as the money was reinvested. I provide the results in Figure 5.\u00a0 In reality, bond yields will not rise or fall each year at a constant rate, but will fluctuate. The overall results will be the same regardless.<\/p>\n

\"\"<\/p>\n

Figure 5.\u00a0 United States 10-year Government Bond Rising and Falling Yields and Returns<\/strong><\/span><\/p>\n

The black line in Figure 5 shows the path of government bond yields through 2019.\u00a0 The green line shows the returns that would occur if interest rates fell by 0.125% each year for the next 10 years, and the blue line shows what would happen if interest rates rose by 0.125% each year for the next 10 years.\u00a0 The cumulative effect of rising interest rates would be to generate negative returns to bondholders from 2019 by 2029.\u00a0 On the other hand, if government bond yields continue to fall, the decline in the total return is reduced by the capital gain shareholders would receive allowing returns to follow more closely to the bond yields that existed in the 2010s. Since the green line of falling interest rates adheres more closely to the actual behavior of interest rates between 2009 and 2019, it would seem more logical to predict falling interest rates over the course of the 2020s than rising interest rates.<\/p>\n

Trouble in Bond Paradise<\/strong><\/span><\/h3>\n

Whether you expect bond yields to rise or fall over the next 10 years, the conclusions reached in this paper should raise concerns for any fixed-income investor.\u00a0 If government bond yields rise over the next 10 years, by the end of the decade, if not earlier, fixed-income investors will receive a negative return on their investment.\u00a0 On the other hand, the only way for fixed-income investors to avoid negative returns is to hope for falling bond yields.\u00a0 Rising bond prices will offset the decline in yields, but at the same time may only delay the inevitable losses that fixed-income investors will eventually have to incur when interest rates rise at some point in the future.<\/p>\n

What is true of the United States is true of the rest of the world.\u00a0 As Figure 4 indicates, 10-year government bond yields are lower than they are in the United States in virtually every developed country in the world. There is currently over $10 trillion in notes and bonds with a negative yield.\u00a0 If bond yields don\u2019t rise, investors will receive a negative return because of rising bond prices.\u00a0 If bond yields do rise, investors will receive a negative return because of rising bond prices.<\/p>\n

Some would say that a return to rising bond yields is inevitable, but this isn\u2019t necessarily true.\u00a0 Bond yields fell throughout the 1800s.\u00a0 Yields fell from 5.345% in 1803 to 2.43% in 1897.\u00a0 There is no reason why bond yields might not fall for decades if the Federal Reserve can keep inflation under control. Population growth and economic growth may remain stagnant and constrain any increase in inflation or interest rates in the future. Data on these indicators are available through the GFDatabase and GFD Indices. All of the 10-year bond yields extend further back than is displayed in Figure 4. Fixed-income investors may be condemned to lose money during the next decade.\u00a0 The only question is how much?<\/p>\n","protected":false},"excerpt":{"rendered":"

Bryan Taylor, Chief Economist, Finaeon The 2020s have begun. \u00a0During the 2010s, the fixed-income market has done things no one would have predicted when…<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[1,124],"tags":[],"class_list":["post-2760","post","type-post","status-publish","format-standard","hentry","category-insights","category-january-2020"],"acf":[],"_links":{"self":[{"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/posts\/2760","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/comments?post=2760"}],"version-history":[{"count":3,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/posts\/2760\/revisions"}],"predecessor-version":[{"id":2799,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/posts\/2760\/revisions\/2799"}],"wp:attachment":[{"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/media?parent=2760"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/categories?post=2760"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/maxrezmedia.com\/website_131ddb8a\/wp-json\/wp\/v2\/tags?post=2760"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}