A daring thesis, without a doubt. If you think that donor is crazy now, read my arguments.
Many investors wonder why the interest rate on ten-year government bonds is below the inflation rate. The situation is particularly dire in the United States. An interest rate of 1.5 percent is offset by an annual inflation rate of five percent. But I’ll just ask the other question: Why should the long-term interest rate be higher than the inflation rate at all? Because it was always like that in the past? Maybe it used to be just coincidentally.
The yield on a ten-year government bond is formed on the market by supply and demand, just like any other price on the financial markets. The inflation rate is not included in this pricing mechanism at all. I can run to the bank ten times and say that the inflation rate in Germany is two percent and I kindly want two percent interest, but that doesn’t change anything at all.
In the same rhythm
There is simply more capital available to invest than loans are willing to be taken out. The yield on a ten-year US government bond, i.e. the interest rate on long-term loans, fluctuates at the same rate as the ISM Manufacturing purchasing managers’ index, which is a measure of US economic activity. The connection makes sense, the better the economy runs, the more loans are in demand and the interest rate rises, in the doldrums the opposite happens.
Gebert stock market indicator index
The paradox of government debt and bond yields
There is no similar consonance between bond yields and core inflation. Once you get rid of the idea that interest rates have anything to do with inflation, a lot becomes clearer. For example, this solves the paradox that bond yields have fallen dramatically in the last few decades, in which public debt has increased explosively around the world. The higher the debt in your own currency, the more money is available for investment – including in long-term government bonds – because only a fraction of the debt borrowed is invested.
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In the last year of the Bush administration and the eight years of the Obama administration, the US doubled its debt level, that is, took on more debt than in all of American history combined. This greatest debt orgy in peacetime did not lead to an increase in the yield on ten-year US Treasuries, but rather to a decline from almost 4.5 percent to 1.5 percent.
Japan had started with the escalating debt and landed accordingly earlier at zero percent interest. With this interpretation, the future forecast is easy. The renewed avalanche of debt unleashed by President Biden will – not immediately, but over the next two to three years – lead to a dramatic decline in US bond yields.
What does this mean for the investment strategy?
Of course, if there is no longer any kind of interest to be earned in any major industrialized country, stocks will in principle become more attractive. Even a dividend yield of a percent or two is better than nothing. However, gold should be the main beneficiary, as the gold price usually rises when the US bond yield falls, and vice versa. Furthermore, the economically insensitive stocks from the areas of consumer goods, pharmaceuticals and utilities, which are often bought as a bond substitute, are preferable to industrial stocks. In phases of falling US long-term interest rates, they have performed significantly better than the index in the past. In contrast, stocks from the automotive, chemical and electrical industries were able to shine with a rising US bond yield.
I know my thesis sounds unusual. All of the experts at major US banks and US brokerage houses predict bond yields of 2.5 to 3 percent next year, but I am absolutely convinced that bond yields will drop to zero percent in the next few years.