Expert View: Falling British bond yields: a tale of the unexpected
Given the inflationary pressures, the decline is truly remarkable
Sunday 21 May 2006
Consider the following facts: the UK government will borrow £37.2bn this year; an upward trend in public sector pay was underlined last week as university lecturers threatened not to mark exams to back up a pay claim; the US consumer and the US government continue to borrow hugely; and oil prices are at record levels.
This should all be very bad news for bond markets, and US bond yields have indeed been rising recently (which means falling prices). But on a two-year view, it is more notable that UK bond yields have fallen markedly since 2004. The average yield on 10-year corporate bonds this year is 4.8 per cent, against 5.8 per cent two years ago. This comes late in the economic cycle - two years after the US Federal Reserve started tightening policy.
The American economy has enjoyed sustained growth since 2002. This year, the long-delayed recovery of the Japanese economy and continuing strong growth in China and India have contributed to an upsurge in oil and other commodity prices. Given these potentially inflationary late-cycle pressures, the continuing fall in UK bond yields is truly remarkable.
There was a much larger decline in corporate bond yields from 6.8 per cent in January 2000 to 4.6 per cent in mid 2003, but that was unsurprising. The world economy went into recession in 2001 and recessions are usually good for bonds. Oil prices were around £30 a barrel, less than half today's levels. The dot-com boom had ended and investors escaping from risky equities moved into bonds, driving prices up and yields down.
But what can explain the more recent steady downward trend in corporate bond and gilt yields?
One common explanation is that pension funds have been buying gilts following legislation that obliges them to reduce their deficits.
The emergence of large deficits under the new FRS17 accounting standard has also caused pension funds, it is said, to rebalance their asset portfolios. They have sold equities and bought bonds to reduce the risk of these deficits recurring.
Because pension fund liabilities are measured by discounting future expected pension payments at an AA-grade corporate bond rate of interest, the fall in bond yields would, other things being equal, make pension deficits worse. It is for this reason that pension funds are sometimes accused of making a rod for their own backs by switching into bonds.
Some argue that the desire to stabilise pension fund deficits by reducing the exposure to equities has resulted in higher deficits, as bond purchases have driven yields, and hence the relevant discount rate for liabilities, downwards.
However, the evidence for such a causal link is weak. There is nothing particularly new about British pension funds shifting into bonds. It is a natural consequence of an ageing population. Even if there has been an acceleration in this shift (possible, but by no means certain), the effect on global bond markets would be negligible.
The main influence on bond markets over the past 15 years has been the remorseless reduction in inflation and in inflationary expectations.
The worldwide shift to independent central banks has been one cause of this. The continuing fall in the price of manufactured goods from the newly industrialised countries (notably, but not exclusively, China) has been another. The downward pressure on wages in the main industrialised countries as a result of immigration (from the south in the US and from the east in Europe) is a third cause.
These are powerful forces. Just how powerful is revealed by the continuing fall in bond yields at a point in the economic cycle when they would normally be expected to rise.
The behaviour of the pension funds, although it may reinforce the decline in yields, is really only a sideshow.
Bill Robinson is director of economics at PricewaterhouseCoopers
- 1 'Fire at every person you see': Israeli soldiers reveal they were ordered to shoot to kill in Gaza – even if the targets may have been civilians
- 2 Italian police 'reveal' what Jesus looked like as a young boy
- 3 General Election 2015: 14-year-old boy asks Nick Clegg – 'can you kill Katie Hopkins?'
- 4 Garland shooting: Isis claims attack on Prophet Mohamed cartoon contest in Texas as its first action on US soil
- 5 Met Gala 2015: Beyoncé manages to out-skimp Rihanna, Miley and Kim Kardashian combined with near-naked ensemble
Italian police 'reveal' what Jesus looked like as a young boy
Who should I vote for? The Independent quiz matches best political party for undecided voters ahead of the general election
Met Gala 2015: Beyoncé manages to out-skimp Rihanna, Miley and Kim Kardashian combined with near-naked ensemble
Syria's 'circle of hell': Aleppo residents describe children without heads, streets filled with blood and injuries never before witnessed by surgeons
General Election 2015: Photographic history of Bullingdon Club tracked down - including new picture of David Cameron in his finery
In defence of liberal democracy
Over 50,000 families shipped out of London boroughs in the past three years due to welfare cuts and soaring rents
EU asylum policy is 'a direct threat to our civilisation', says Nigel Farage
The Rothschild Libel: Why has it taken 200 years for an anti-Semitic slur that emerged from the Battle of Waterloo to be dismissed?
General Election 2015: UK will be 'run for the wealthy and powerful' if Tories retain power, Labour warns
Schools forced to act as 'miniature welfare states' with teachers buying underwear and even haircuts for poor pupils
iJobs Money & Business
£20000 - £25000 per annum + Uncapped commission: SThree: Can you speak German,...
£25000 - £30000 per annum + benefits: Ashdown Group: An exciting opportunity f...
£215 per day: Ashdown Group: Junior Project Manager (website, web application ...
£40-50K: Guru Careers: We are seeking an experienced Software Engineer / Softw...