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For our second chart extraordinaire in a series of three, senior portfolio manager Jeroen Blokland picked this one entitled ‘Bond Madness!’. This shows how Swiss 50-year bond yields went negative in 2016 due to massive central bank bond-buying programs, which puts the price up and the yield down. A negative yield means the investor actually pays the government for the privilege of lending them money, a scenario is unprecedented in history and unsustainable on any logical level.
“I chose this chart to illustrate the extreme monetary policy that has been implemented by central banks, especially in Europe and Japan, in the aftermath of the financial crisis,” says Blokland, who helps manage a multi-asset portfolio including bonds whose yields have become negative. “The impact of this policy was so overwhelming that even the yield on the 50-year Swiss government bond yield went negative in June 2016. Hence, you had to pay to give your money to the Swiss government for 50 years.”
“Another anomaly is that under ‘normal’ conditions, you would expect the yield of a bond with a very long maturity to be higher than a bond with a short maturity. But this trend reversed as the Swiss yield continued to fall, and for a significant part of 2016 you got more yield on a 1-month US Treasury bond than on a Swiss 50-year bond. That is a good way to show the bond madness that characterized 2016.”
So how has this happened? “The core problem here is that in order to prop up inflation expectations, which fell dramatically due to the reduction of debt after the financial crisis and the collapse of commodity prices, central banks around the world engaged in massive bond buying programs,” Blokland explains. “The idea was that pushing interest rates down would provoke spending and investment, which, in turn, would push up inflation. However, while the first part of pushing down yields has worked extremely well, inflation expectations have remained subdued, forcing central banks to buy even more bonds, with the final result that even long-term yields have fallen below zero.”
However, yields on both US and Swiss government bonds are now expected to rise in 2017. “I expect both lines in the chart to go up,” Blokland says. “The Fed is way ahead of European central banks and has chosen a path of gradual normalization. While the gap between US and European yields is of historical proportions, the absolute yield levels in the US remain pretty low as well. So in Europe we will need to leave the extreme yield levels behind us as the economy improves, and central banks here too at some point will have to stop buying bonds. This is why I also expect the blue line for the Swiss to behave much more erratically, as investors have to prepare for less stimulus.”
Longer-term, this is not great news for investors, Blokland says. “Rising yields are bad news for bond prices, which could come under pressure in 2017. The very important notion here is that long-maturity bonds in Europe are more exposed to rising rates than short-term US bonds, for the obvious reason that longer-term bonds have higher durations. But this is exacerbated by the fact that, given the extremely low bond yields, these durations are even higher than what they used to be, making the sensitivity to rising yields even bigger.” Fasten your seat belts!
If a picture is worth 1,000 words, what value a chart that says it all? Robeco Investment Solutions spends many hours compiling charts to illustrate a current issue. Most are made in-house, while some are externally sourced. We asked the team’s three enthusiastic chartists – Lukas Daalder, Jeroen Blokland and Peter van der Welle – to name one that expertly depicts what they believe will be a major investor issue for 2017.