- Bond yields have been falling since January.
- This has nothing to do with monetary stimulus.
- Falling yields signal declining inflation and growth expectations.
- Stocks are the only option for today’s investor.
As usual, the financial media is deeply confused about the relationship between monetary policy and bond yields. Falling bond yields require an explanation. Today's WSJ gives it a stab:
"Bond yields are - once again - plunging worldwide. The reason for this revived buying among fixed-income investors is that central banks are - once again - signaling their intent to ease monetary conditions in yet another bid to kick-start sluggish economies and forestall a downward spiral in prices, or deflation. The prospect that central banks will continue to inject money into the world's bond markets...has acted as a green light for the world's bond buyers."
Bond yields are declining because central banks are pursuing inflationary policies. Wasn't it just yesterday that we were being told that quantitative easing would cause hyperinflation and double-digit bond yields? Now we are supposed to believe that monetary stimulus causes bond yields to fall. Inflation is deflationary.
A second myth being retailed now is that central banks have been providing monetary stimulus since the Crash:
"The global economy hasn't fired up despite all the heavy monetary stimulus,'' said Mary Ann Hurley, vice president of trading at D.A. Davidson & Co..."We continue to stay in this ultra-loose monetary-policy environment" which supports bond prices, said Jason Brady, head of fixed income at Thornburg Investment Management. (from today's WSJ)
It should by now be evident to any market participant who has taken Monetary Policy 101 that there has been no "heavy monetary stimulus" and that we are not in an "ultra-loose monetary policy environment." There are a number of ways to judge a central bank's policy stance, and almost all of them indicate that none of the major central banks (aside from the PBoC) has been providing "massive stimulus." These measures include money growth, inflation, nominal growth, real growth, expected inflation and bond yields. For the Fed, the ECB, the BoE and the BoJ, all of these indices have been flashing "TOO SLOW" since the Crash. Fitful efforts at QE have failed to move any of the dials.
Falling bond yields are not about the prospects for more stimulus. They are instead a signal of the market's loss of faith in the ability of the central banks to provide adequate monetary stimulus. The market looks into the future and sees very low money growth, declining velocity, less than 2% inflation, 3% nominal growth and 1% real growth. Such an outlook justifies a 10-year yield of 2.5%.
And by the way, we are not in a "new era" -- we are in an old era called the mid-20th century, when bond yields remained below 3% for twenty years, from 1935 to 1956. Of course, this is all new to the baby boomers, who can only remember the inflationary era after the breakup of Bretton Woods. We will need to erase those inflationary memories and reacquaint ourselves with our parents' era when 3% bond yields were considered high, and a 2.5% yield was considered normal. There is nothing "extreme" about low inflation and low interest rates.
What About Stocks?
Declining bond yields are bullish for stock prices. The 10-year yield has declined from 3% in January to 2.5% today. Stated differently, the P/E on the 10-year bond has risen from 34 to 40. This raises the equity premium, which makes equities more attractive, and justifies a higher multiple. Today, the forward multiple for the S&P is 15.8x, which represents an earnings yield of 7%, which is certainly more attractive than 2.5%.
Additional disclosure: I am long stocks and bonds.