Ever lower government bond yields are not “free money”

In terms of interest-rates there have been several phases in the credit crunch era. First we saw large reductions in official interest-rates which were badged as temporary and emergency but of course now look ever more permanent. Then we had various ” extraordinary monetary measures” such as QE to reduce longer-term interest-rates and bond yields. Some years later we saw a new phase of interest-rate reductions as an increasing number of nations took their official interest-rates into negative territory. This was often accompanied by yet more QE with my own country joining the new QE wave only last month. As I pointed out from the early days this has looked much more like a type of junkie culture than any cure unless of course someone can think of a cure that takes 8 years or so not to work. After all if it was working why are we where we are? The one country which is trying to buck the trend has managed only one interest-rate increase so far and keeps mentioning negative interest-rates.

Fiscal Policy

There has been an extraordinary boost here provided by the fall in sovereign bond yields and this has been highlighted by Fitch.

Cash flow benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped in response to central bank monetary stimulus.

We are left wondering if this was the plan all along! Treasuries around the world will no doubt have been keen to rubber stamp QE plans by central bankers which will reduce their borrowing costs. What price independence anyone?

We also get an idea of the boost provided.

Relative to yields available in 2011, global investors are foregoing over $500 billion in annual income on $38 trillion in currently outstanding bonds as a result of the collapse in sovereign yields.

A US $500 billion a year gain to government’s is nothing to be sniffed at and provides a backdrop to the current cries for more fiscal stimulus. It has been produced as a result of this.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

Some countries have benefited more than others.

The largest declines in weighted-average sovereign yields among the top issuers over the past five years have been seen in Spain (down 422 bps) and Italy (down 413 bps). Both countries faced elevated spreads during 2011, when investor concerns surrounding Eurozone risk were peaking.

That is interesting as their economic performance proves that this is no panacea on its own. Spain has seen an economic recovery whilst Italy continues to struggle and currently they could not look much more different. There is something of a contradiction here as Italy benefits more from the change ( US $79 billion per year) than Spain ( US $45 billion per year).

For other countries the Financial Times offers us these estimates.

Japan has saved more than $95bn a year as a result of the decline in rates, while the US, UK and Germany collectively pay $104bn less annually, the study estimates.

Also some countries now get paid to borrow.

Stimulus from the European Central Bank and Bank of Japan has unleashed a rally across fixed income markets, with nearly $13.2tn of debt trading with a yield below zero at the end of last week. Japan, France, Germany and Switzerland are now paid to issue short-dated sovereign bonds.

It is not just short-dated bonds as ten-year yields in Japan,Germany and Switzerland are negative as well. Being paid to borrow is a credit crunch phenomenon which impacts on the number below which must have Bond Vigilante’s in floods of tears.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

The UK

Let me bring a couple of things together which is that whilst it heads in another direction Fitch does seem to understand the correct methodology.

Fitch notes that the effects materialise as higher coupon bonds mature and are refinanced with low or negative yields.

If we look at the UK we see that conventional issuance will be of the order of £100 billlion this year which with yields some 1.8% lower than in 2011 is an annual bonus of £1.8 billion. Actually against OBR forecasts it is a lot better because it was assuming more like 5% for Gilt yields so the annual gain is currently of the order of £4.3 billion.

Also Fitch skirts around something else which is that central banks invariably return the coupons and yield from their QE purchases to the home treasury. Here is the latest data on the Bank of England.

In July 2016, there was £1.1 billion transferred from the BEAPFF to HM Treasury, bringing the total money transferred to HM Treasury under the APF scheme to £5.0 billion in this financial year-to-date (April to July 2016).

The Bank of England entrepreneurial income for the financial year ending March 2016 (April 2015 to March 2016) was calculated as £11.9 billion.

Not all of it is counted in the public finances believe it or not but we know that as the Bank of England expands its conventional QE operations by another £60 billion the benefit to HM Treasury will rise.

It is really quite clear why politicians steer clear of this sort of thing as people may wonder why the public finances do not look a lot better……?

Even the losers get lucky some times

Tom Petty is right here because whilst Fitch is in effect whining on behalf of income investors some have pocketed a lot of cash.

Given the significant downward moves in interest rates over the past five years, many investors have already seen large gains in their bond portfolios.

There have been extraordinary gains so where have they gone? Who now has all this wealth? i think we should be told don’t you? Also someone should tell Fitch that the sentence below makes things worse and not better.

In addition, central banks’ holdings of sovereign securities have grown sharply, mitigating the prospective impact of ultra-low rates on private investors.

Future investors and savers are hit

We are back to this issue.

Still, for many “buy and hold” income-oriented investors, the roll-off of maturing securities requires that new cash be invested at much lower coupon rates. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.

That is a polite way of explaining how many of the business models for longer-term saving such as defined benefit pensions have been blown up by the policies Andy Haldane of the Bank of England is so keen on. Not his pension though as the UK taxpayer backs it.


If we take a broad brush approach to the falls in sovereign bond yields we see that there have been two main gainers. Firstly existing holders of government bonds and secondly governments which pay less for new borrowing and receive transfers from the operations of their central banks. Quite a wealth shift in the first instance and an income shift in the second. This has the implication that monetary policy has strong fiscal effects which blows up the independence bubble that central bankers and their acolytes keep trying to maintain.

But there is a price and it is in the process of being paid by people and companies who reply in income both now and in the future. It has become a lot more expensive if you try to purchase it and in other variants is either very low or zero. So future income has been taken from them and they represent not only pensioners and savers both now and in the future but companies with pension plans.

Oh and who has all the new wealth? What economic benefits has it brought?



21 thoughts on “Ever lower government bond yields are not “free money”

    • Hi thepessimist

      The central bankers want us to be like this.

      “I’m just a poor boy, I need no sympathy,
      Because I’m easy come, easy go,
      Little high, little low,
      Any way the wind blows doesn’t really matter to me, to me.”

      but they do not want us to be like this.

      “Open your eyes,
      Look up to the skies and see,”

  1. So, let me get this straight:
    1. The BoE buys gilts, which drive the yield down;
    2. The BoE then hands back the yield it gets from QE purchases;
    3. The Government therefore pays nothing at all on QE purchased gilts;
    4. The Government pays almost nothing on the rest, as the yield is now so low;
    5. Asset prices rocket (either because the QE gilt buying drives up the price or because mortgage rates are at all time lows or because people are driven to buy shares);
    6. There is no plan even in concept to reverse any of this.

    Why do politicians do this?
    1. House price rises are vote winners and, as you have pointed out, don’t affect the inflation numbers;
    2. Poor pension returns can be blamed on the pension firms (or, in extremis, Sir Philip Green);
    3. They can spend more without having the inconvenience of raising taxes.
    It sure looks and feels like a giant Ponzi scheme to me.
    What could go wrong?

    • One other little reason why it is in the interest of politicians to inflate asset prices – IHT. Go back 15 years, if my wife and I had died the tax on our joint estates would have been about 6%, today about 29% largely through asset price inflation.

    • Your mention of Sir Philip Green is very relevant.

      I once thought he was a shrewd businessman, but his performance in connection with the BHS pension fund was extraordinary. He had a perfect explanation as to the problems of the pension fund, being those Shaun has pointed out in respect of many funds…and he didn’t use it!
      Were his PR advisers asleep? Useless? Or is he really just not a very bright man whose success is solely down to good luck?

      • I could not agree more. He failed totally to differentiate between the unbelievable dividends to a shareholder (AKA wife) who lived in a tax free zone from the damage done to the pension fund.
        IMHO, it would be fairer if he repaid the dividends than be asked to fund the pension deficit.
        In his defence, I did not see one journalist make the distinction.

        • Well, that is precisely the problem…the poor standard of financial journalism! And apparently Green’s understanding of finance too, but he surely understands personal gain.
          The above is why we all read this blog: proper analysis and explanation, “not available in the shops” as an old tv ad used to say (KTel?….it was a long time ago…)

    • Also given the massive reduction in net interest payments that the Government is having to make how on earth is it that we have such a large deficit?

      • Hi Laurie and welcome to my corner of the world wide web

        That is an excellent question which places like the Financial Times and Wall Street Journal should be asking regularly. I guess the exclusive interviews with central bankers etc. would dry up if they did….

    • James Spot on about Green ,unbelievable that he did not put the blame for the pension deficit where it belongs,the politicians.
      Going back to Brown’s tax on pension dividends,their failure to ensure good governance in the financial markets’light touch regulation’ criminally irresponsible.
      Then when the crash happened their solution was lower interest rates and more debt?????????????????Massively increasing pension scheme liabilities.
      The greatest wealth transfer in history is happening in plain sight yet the population can’t see it,we the population are being fleeced and made to work longer hours and retirement has been abolished.
      It takes two good wages to get a mortgage for a ridiculously priced house.
      This will all end disastrously and the collapse of the economic Ponzi scheme will impoverish millions of people.

      • pension Funds need to re think their strategy and reform to an equity dividend based model with quite a few Corporate bonds and a much reduced Sovereign bond holding, after all, the Govts are busily buying their own issuance so leave them to get on with monetizing the lot.

  2. Hi Shaun

    unless of course someone can think of a cure that takes 8 years or so not to work.

    Errm … Austerity, or at least austerity as practised by our ex-Chancellor?

  3. Whilst not perfect; it seems to me that gold is now the only game in town….putting aside the notional paper ‘gold’ contracts and ETF gold, which seem to be on the verge of imploding.

    • You are right gold is a finite resource and yield per tonne currently being mined are a fraction of historical records.
      Central Bankers strangely seem to believe that they can expand currency supplies to infinity with no consequences.
      Those holding the ‘pet rock’ will be protected when the fiat Ponzi scheme melts down it is not if it when.
      If you think this is a conspiracy theory history shows all fiat currencies fail,we are following the well trodden path,over spending,increases indebtedness,money printing……devaluation……,implosion.

        • Monetary systems do need to be adjusted every few decades but the refusal to take any steps that might prevent us going over the economic cliff,is beyond belief,the system is failing but their answer is expand the currency,monetise the debt,tactics that are certain to fail and they must know this.

      • My point is, I believe the authorities do know the inevitable outcome of their actions but they also “know” a return to something like a gold standard will not work either as was proved in the past and they have no other ideas so they continue with the same which has not fully broken….yet.

        Equally, I have no ideas as to what the answer is re the monetary problems for that matter.

  4. ‘So did the “Gold Standard”…….’
    the gold standard didn’t really fail at all. The problem was that the US government could not constrain their spending to what their currency and wealth allowed, under the gold standard.
    The debt that Nixon, and others, had created didn’t not relate relate to the gold they had. Therefore they chose to print and spend and forget about gold completely. It was the first step that brought us to where we are now. Marvellous………

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