The Independent Adviser for Vanguard Investors
•
July 2014
•
13
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800-211-7641
A LOT OF INK
has been spilled recently
asking why bond yields have declined
this year and almost as much explain-
ing why they’re bound to begin rising.
The one question that hasn’t been asked
is why everyone believes yields have to
head significantly higher.
At the start of 2014 everyone “knew”
that bond yields were headed higher, but
the year hasn’t played out that way. The
yield on the benchmark 10-year Treasury
is currently trading around 2.52%, but
in late May, it threatened to dip below
2.40%. This is a substantial decline from
its year-ending 3.03%. Earning 2.5% or
so for the next 10 years doesn’t sound all
that good on its own—at least not to my
ears. So what’s driving demand?
When 2.5% Is Sumptuous
Depending on your objectives and
alternatives, the 2.5% yield on the
10-year U.S. Treasury actually looks
pretty darn good, particularly when you
compare it to other top-ranked sover-
eigns around the globe.
The chart below plots a number of
10-year sovereign bond yields with
those from developed markets in dark
blue, emerging markets in light blue and
the U.S. in black. Note that the 10-year
Treasury yields more than bonds from
many of what you and I would think of
as strong, developed market economies,
including Germany, Japan, France and
Canada. Even bonds from previously
troubled European countries like Spain
and Italy now yield less than 3%, so
while you may pick up a hair more
yield there, it comes with a heaping
dose of risk. Even the emerging mar-
kets don’t offer great advantages, with
several countries’ bonds sporting yields
below 4%.
Add in the fact that the U.S. Treasury
market is the deepest and most liquid of
any securities market in the world, and
that Treasurys are the flight-to-safety
asset of choice, and a yield of 2.5%
suddenly doesn’t look half bad. That’s
particularly true if you
have
to buy
bonds—and there are plenty of people
that do, such as mutual fund and pen-
sion managers.
Theresultofthisisthat
Intermediate-
Term Treasury
’s
SEC yield of
1.55%—not to mention
Total Bond
Market
’s 2.00% yield—looks attrac-
tive compared to
Total International
Bond
’s 1.30% yield.
But aren’t rates poised to rocket
higher as we enter a new bear market
for bonds?
What’s Behind Door #3?
Looking to history as a guide, the
chart below is the standard view of the
10-year Treasury yield that most bond
investors are familiar with since regular
bond auctions began in the early ’60s.
In essence, it appears that bond yields
have either been on one grand sweep
higher (a bear market for bonds) or a
long ratcheting down (a bull market for
bonds). But isn’t there a third option—a
sideways, range-bound environment?
Well, if we step back and extend
our view even further, as I do in the
chart above tracking long-term U.S.
Government bond yields back to 1926,
you can see that there is precedent for
interest rates to be range-bound. For
nearly four decades from the mid-
1920s to the mid-1960s, yields were
range-bound between 2% and 4%.
It has been five years or so since
the 10-year Treasury’s yield dropped
below 4%. Could we be five years into
yet another range-bound market? It’s
possible.
Or maybe the past five months have
just been a pause in a slow grind higher
in rates. We won’t know until it’s over,
but just because rates are low today
doesn’t mean a sharp, sustained move
higher and a steep decline in bond
prices are coming tomorrow.
n
BONDS
Yields in Context
History of Range-Bound Rates
5/29
5/34
5/39
5/44
5/49
5/54
5/59
5/64
5/69
5/74
5/79
5/84
5/89
5/94
5/99
5/04
5/09
5/14
0%
2%
4%
6%
8%
10%
12%
14%
16%
10-YearYieldsAcross theGlobe
Japan
Switzerland
Germany
Netherlands
France
Sweden
Canada
U.S.
Spain
U.K.
Italy
South Korea
Mexico (USD)
Australia
Colombia (USD)
Portugal
Brazil (USD)
Greece
0%
1%
2%
3%
4%
5%
6%
Developed Markets
Emerging Markets
10-YearYieldsNearTheir Lows
4/64
4/69
4/74
4/79
4/84
4/89
4/94
4/99
4/04
4/09
4/14
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
Source: Bloomberg
Source: Bloomberg
Source: Ibbotson
That 2.5% yield on the
10-year U.S. Treasury
actually looks pretty
darn good, particularly
when you compare it to
other sovereigns.
