Calvert  News & Commentary

It's a Low, Low Yield World

All eyes are on the major central banks, as we keep close watch on inflation and yields.


Untitled Document

By Steve Van Order, Fixed Income Strategist

Steve Van Order, Fixed-Income Strategist Steve Van Order,

Last week global investors woke up to a little bit of risk. Economic data in general were weak and central bank officials in the U.K. and the euro area made comments very supportive of the safe-haven government bond markets. The bond market started the year positioned for a rise in yields, and stuck with that position, only to get washed out in recent days on the words of the central banks and soft global economic data. A maxim among government bond traders is that the bond gods will inflict the most amount of pain possible over the largest number of traders. Sure, this reflects the stereotypical psychology of the typical Bondland resident, but in our experience the maxim tends to hold up.

Let's boil all of this movement in bond yields down to a gang of four culprits—the major central banks of the U.S., U.K., Japan, and euro area. All are guiding markets to expect very low policy interest rates for a long time. Some have been a bit vague in this guidance, some more clear, but the intent has recently become more obvious and the global bond markets have responded.

It's a low, low yield world, isn't it? To get a government bond yield much over 3% you have to venture into emerging government or high yield markets. In advanced economies, consumer prices by and large have disinflated or deflated, and the central banks are running unorthodox monetary policies, so yields are low throughout that part of the world. This of course has spilled over into global markets, including emerging markets, greatly depressing yields there as well.

Yet, in a low, low yield world, in the emerging markets inflation rates can widely differ, as can yields. But, compared to prior episodes such as those of the late 1990s, last year emerging market central banks were well-armed with foreign exchange reserves and also were quick to hike rates if needed. In a low, low yield world, the U.S. high yield index average yield is around 5.5%. You might own Greece at about 6.8% or Brazil at 12%. It's tough to get paid to take advanced or emerging economy government bond risk. What level of risk works, given investor needs?

The next time you are dreading the low available yields on U.S. bonds, first review what the gang of four1 is up to, then grab The Economist and read down that back page of global government bond yields. In that the list of bond yields, the relative yield advantage of the U.S. bond market sticks out, higher than Japan's and Europe's but not dramatically lower than that of many emerging markets, especially on a real yield basis (that is, taking into account inflation).

See our 2014 outlook roundtable discussion here.

1 Quiz (no looking at Wikipedia first): The U.K. band Gang of Four was named after: a) the major central banks, b) the top leaders under Mao during the Cultural Revolution, c) the top automakers or d) the four earliest and most important punk rock bands.

Frequently Used Terms:

What is a "yield curve?"
The yield curve shows the relationship between the time to maturity of the debt for a given borrower, in a given currency and the interest rate (or cost of borrowing).

The shape of the yield curve summarizes the priorities of all lenders relative to a particular borrower (such as the U.S. Treasury). In general, lenders are concerned about a rising rates of inflation or a potential default, so they offer long-term loans for higher interest rates than they offer for shorter-term loans. When lenders are seeking long-term debt contracts more aggressively than short-term debt contracts, the yield curve inverts, and we see lower interest rates, or yields, for the longer periods of repayment so that lenders can attract long-term borrowing.

What is the "yield spread?"
Simply put, the yield spread is the difference in yield between two bonds. If one bond yields 4% and another bond yields 5%, the "yield spread" is 1%. Yield spread are typically expressed in basis points, where 100 basis points make up 1 percentage point. When the difference between two yields "widens" it increases, and when it "narrows" the difference decreases.

This commentary represents the opinions of the author as of May 16, 2014 and may change based on market and other conditions. These opinions are not intended to forecast future events, guarantee future results, or serve as investment advice. The statistics have been obtained from sources believed to be reliable, but the accuracy and completeness of this information cannot be guaranteed. Neither Calvert Investment Management, Inc. nor its information providers are responsible for any damages or losses arising from any use of this information. Calvert may have acted upon this research prior to or immediately following publication. In addition, accounts managed by Calvert Investment Management, Inc. may or may not invest in, and Calvert is not recommending any action on, any companies listed.

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