The bond market


The remarkable demand for low-yielding government bonds

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The soaring bond prices and near zero yields is as much a reflection of liquidity preference as lack of credible investment option that has a clear future; the range of uncertainty is no way diminished by the flow of money, in fact it is adding to it. But treasury bonds are a different story. Even if I assume that a bulk of the preference for treasury bonds stems from those who want to create insurance for its currency, we have seen actually that these currencies have been depreciating, like the Yuan or the Rupee. This leads one to the stunning inference that America has become the chief exporter of capital to the external world for buying labor (both skilled and unskilled) at the cheapest possible cost. The acceleration of this activity (export of capital and import of labor) effectively boils down to heightened unemployment within the national territory and a downward wage spiral, which is also the very reason why inflation is tamed at its best.

Procyon Mukherjee

Jasiek w japonii



Many see a bond bubble. Predicting when it will burst is the trick. If there is an event or development that triggers inflation, that should burst the bond bubble. There will be a scramble to dump bonds as yields begin to rise. The central banks will try to buy them up and keep yields from rising, but will not be able to stop it.



WT Economist in reply to eternalskeptic


No free lunch. China is not the land of rock sold constitutional property rights provisions. Imagine if the Chinese, having lived poor to save and now facing old age, find the U.S. and European assets they had invested in defaulted on or inflated away? The current regime (or its replacement) might decide that nationalizing the Chinese assets of residents of countries that had stiffed them might be justified to meet people's basic needs.

Yes Chinese banks give you 3% return. However, only recently has China gotten official inflation down to around 3%. So what I am saying it is pointless to have even a 50% interest rate if inflation is 50% you only break even.

Then add in complications and risks of currency valuations as everything is fiat currency. Thus your 3% Chinese rate might also be eroded if the Chinese currency depreciates or their government stops it from appreciating (as it has done before), then when you flip back to US dollars you have lost money.

So with this second part, it may be very much worthwhile for the say the Greeks to buy US treasuries because not only do they have better odds of getting their money back, if the Greeks default (or continued issues in the Euro with no resolution) the Euro currency will fall in value versus the US dollar. Thus in this example the Greeks will have actually made money when they return to the Euro.


There is another view of the cause altogether. It is the one I described in the Financial Times in September 2010, under the heading 'Riskiness of bonds may be overstated':

Of course, I might simply have been lucky then in my analysis. But in my view, it is demographics that are primarily driving demand for Treasuries and gilts, not central banks.

The Western BabyBoomers (those born between 1964-70) are now 29% of the population - 272m people. They benefit from an extra decade of life expectancy compared to their parents and grandparents. This means they simply have to save more, and also spend less, in order to fund their longer-than-expected retirement.

Equally, it means they are worried about return of capital, not return on capital. So they prefer to save with the JUUGS (Japan, UK, USA, Germany, Switzerland) rather than the PIIGS.

Seen in this light, the rise in relative bond prices for the JUUGS makes perfect sense, don't you think?

Inspector Grim

Very insightful article. Made more endearing by the sprinkling of a few verses of my favourite poem: Alfred Lord Tennyson's Ulysses.

WT Economist

There are two other factors to consider.

One is lack of trust. With all the extending and pretending going on, with foreclosures deferred to avoid booking losses and firms dependent on low interest rates, anyone investing in a private sector paper asset right now might end up suffering someone else's losses. Basically, there is widespread believe that the rich and powerful are deferring losses in an effort to hide them until they can be dumped on the less well off.

The second is the lack of new private sector assets worth holding. In the U.S., total credit market debt exploded from 1980 to 2008 but has been falling since. Much of that debt was used not for investment but for consumption -- credit card financing, cash out refinancing and home equity lines of credit, companies borrowing to pay bonuses and private equity dividends, state and local governments borrowing to pay pensions and get through economic downturns.

With so little investment, there are few paper assets being created that are worth much. All they are is promises to be poorer in the future in exchange for living richer (or at least not poorer) in the past. You'd be a fool to buy the existing ones; with little market few new ones are created.

What about Bob

A good article.

However, the author does not take into consideration the fact the governments in question, including Germany, run deficits and not surpluses. Meaning they are not paying down their debt and most of them have no plans or ability to begin running surpluses. Looking into the crystal ball, countries especially the United States' budget will only become worse in regards to deficit in the future.

So when, and it will be when because eventually people will realize their money is not safe just as is happening in the PIIGS, rates go up the increase of even 1% interest rate will be crushing to their government budgets driving them further into deficits creating a death spiral that will ultimately result in default.

the central banks will do QE to avoid this and become almost the sole buyers of these bonds and those who are forced buy them via regulations will be scalped. However I do not think this is sustainable and will lead to a greater economic calamity.

It is only avoided now because not because they are in way better fiscal positions than the PIIGS, but simply they are more liquid and not as bad as the PIIGS.

The question is when this will occur.

On another note/comment.

If bonds are giving in effect no return and then when it becomes questionable if the money can be returned or not, I think people will go back in droves to "barbaric" gold as a store of value since there is no counter-party risk in owning physical gold. While you could lose 99% of the value in gold, it has always be worth something, but all those bonds could lose 100% of their value. well maybe 99.99% of their value, as you could always sell the paper to burn in winter time.

The majority of US sovereign debt is purchased by either the central bank, banks attempting to adhere to capital standards, the Social Security Fund, foreign banks to control exchange rates, or by trading partners looking to hedge against exchange risk. All of these, minus the Fed, are purchasing debt as a risk aversion tool. The Fed is purchasing debt to float our monetary system. There needs to be a change in wisdom explaining the financial motivation of different institutions. The question isn’t; can governments pay off the debt, but rather can they service it and do so in a relatively stable inflationary environment. A budget surplus isn’t needed nor strived for. The US has a lower debt expense now than what they had before the recession even after our national debt has more than doubled. Sustainability becomes an issue when the servicing payments are so large that you are incurring additional debt to pay them i.e. Greece. The US, Germany and the UK are far from this tipping point.





Cool Beans

Well the sad thing is that even though the US and Britain do have this benefit, and have access to piles of easy money, and have by luck and sneakily trapped profit hungry investors into this lose-lose option, they are not using this to their advantage by investing heavily, let alone smartly!

D.D. Corkum

I think demographics has a significant part to play in the current low-rate environment. Beating inflation matters when you are in your twenties and focussed on growth, but not so much when you are in your sixties and simply looking for a safe-haven source of income to supplement your retirement.

Adam Onge

The yield curve really needs a nice little hump (like Fergie from black-eyed-peas). Isn't it a bit too steep right now? I don't know, I'm just a casual observer, but I do like humps.


Funny as it may seem, lowering credit ratings has lowered yields in the US…and they continue to be low because of two factors which are accidentally complementary (1) Fed objective of keeping interest rates very for boosting a slowing economy, quantitative easing and jittery stock markets in the US even more jittery investors across the atlantic who are looking for a safe haven for their money…..
So, countries like US, Germany and even UK, irrespective of their Debt to GDP ratios are raising cheap money to finance their deficits. The investors are likely to suffer from negative real returns as inflation picks up in due course (either to the QEs or due to an economic upturn eventually, where rising stock markets would eventually pull up the bond yields). In such an eventuality, the bond holders would make a capital loss if they sell their bonds or suffer from negative yields if they hold it. Either ways, their “safe haven” strategy might not pay off. Better would be, if they invest in gold and move on to equities once the global economy improves.
Their only grim prospect is that the economy remains stagnant with lower inflation or even deflation as has happened in Japan over the last decade. No one would hope or expect such a thing to happen.
Economies like the US cannot continue to consume real goods by selling cheap govt. paper perpetually. The preferred status because of the dollar being the reserve currency is what sustains the US. It is high time that the world finds a new alternative.


In my point of view this article is tellingful of what bond markets price and brings the myths of fiscal-related developments to an end; it may have been fiscal effects (and not exclusively; one must count for cases in which banking effects mattered and for uncertainty induced by adverse signals by inadequate policy makers) that led to a collapse of investment confidence, this time, but the latter and not the former is the causal factor of the crisis.
After all the countries, presently, seen as safe-havens by bond market investors do not lack debts or deficits. The maximization of the probability of returning the invested capital, is certainly related to the potential of growth. Which brings us to the main reason of lowering the yields of US, Britain and Germany: all three have one common growth driver; they control the central bank, whereas South European do not.
The growth origins of the flight-to-safety, experienced in bond markets, brings the myth of fiscal responsibility as a driver of bond yields to an end. So, we must pay tribute to the recently produced literature on sovereign bond spreads arguning that they are driven by expectations and economic sentiment, rather than fundamentals, and to the previous decade's empirical literature on the yield curve's dynamics, arguing that it is the result of expectations on inflation and growth.
Finally, I believe that it is time policy makers started focusing on growth, instead of austerity. Production, trade and innovation, key elements of growth, were always related to prosperity, whereas austerity was always related to misery and conflicts. Better late than never.


Are the sovereign debt markets as manipulated as the LIBOR?

I have lived in Germany and France for the last 25 years. No one in either country is half as worried as the Brits about the 'Euro' crisis. Why is that?

Because the 'Euro' crisis is a (mostly anglo-saxon) finance crisis. It is about getting a German bailout for bust banks, including British banks.

Italy (for instance) has 120% of GDP as public debt but massive private savings so maybe next to no net debt at all. (Private households have to pay off the public debt too at the end of the day.)

The UK has over 450% public + private debt. Unfortunately the UK does not have much of a real economy, only the finance sector which is breaking up before our eyes. So it cannot be paid off which is why the BoE is printing money like there is no tomorrow.

Supposedly the 'markets', who are the same banks who manipulated the LIBOR and who are located guess where (London), think that UK GBP debt which has devalued 25% in the last 4 years against the Euro is really attractive and demand only very low returns to hold it.

They are saying that an Italian pensioner finds it really cool that that part of his pension denoted in GDP sovereign debt has devalued 25% in 4 years, and about 70% in 10 years, and just really, really wants to buy more of it... does that make any sense?

Or is the sovereign debt market manipulated too?



What on earth is safe about the GBP?

The USD is slightly safer:

Omricon in reply to jomellon

GBP is safe because it has a good track record and (if you were reading the article) it can devalue its currency if it wants to.

The Euro on the other hand is dragged down by med countries that treat investors like donaters and who used to inflate and default their way out of every financial crisis every time the first sign of trouble manifested itself.

Of course you dont need to believe me, the facts speak for themselves, everyone wants to buy UK/US bonds at record low returns.



Why? Person A manages his finances well, has a well paying job and a spotless credit history...

Person B is spendthrift, jobless, skill-less and has a bad credit history.

We both use the same currency (the Euro).

Will they pay the same interest if we wish to borrow?


Are US treasury bonds considered to be the safest liquid assets? There are other liquid assets that are actually likely to gain value if not at least hold their current value. It is a neat trick that a government can continue to run a deficit and people will still pay them to take their money.


When will the Economist acknowledge that countries sovereign in their own currency and issue debt in local currency - countries such as the US, UK, and Japan - can set their own interest rate on Government debt?
The US Federal Reserve has a balance sheet of infinite size. They can purchase US government debt on the secondary market at any volume and at any price until the supply of remaining debt and the demand for the securities reach an equilibrium at a lower interest rate. Who can stop them? No one. Investors have no input in the interest rate of US debt unless the FR wants them to have one.
Instead of acknowledging this, the Economist twists itself in knots to try to rationalize their failed model. They say that low yields are to be expected during downturns, but they fail to acknowledge that many Eurozone countries have seen their borrowing rates rise. What explains this behavior? Italy and the UK are similarly-sized modern economies and have markedly different borrowing costs. Why? The Economist never bothers to answer, despite the disproving title of the blog entry.
Next, they claim that investors are buying Treasuries because they're safe, even though they're not safe. First, how does this statment make any sense? Second, if the US were a special case since it has 'reserve currency status', why have Japan, Canada, Australia, Norway, the UK, and New Zealand all seen lower interest rates? Where is the logic of the 'rush to safety' into Japanese debt that yields 0.2% and is rated at A+, several notches lower than many companies that offer higher yields?
And on and on.
Investors know that currency-issuing governments like the US, UK and Japan (and not Greece, Spain, Italy and France) can always pay them back, because these governments can create money at will to pay any coupon or note. And if investors' appetite for these securities ever slackens, the central banks of currency-issuing governments will always intervene to ensure that the government interst rates always meet their targets.


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