ONE of the greatest risks facing the world economy is a wholesale crash in government bonds markets. Yields on UK gilts, US Treasury bonds and others are still much too low – and that means that capital values are too high (the price of fixed income securities move inversely to their yield). Given the extraordinarily large size of government bond markets, and the fact that so many banks, insurers and pension funds are big holders, sometimes for regulatory reasons, this will trigger wealth destruction on a massive scale.
Such a correction has already quietly started. As Leigh Skene of Lombard Street Research points out, yields on 30-year US Treasury bonds rose 0.7 percentage points from their July 2012 lows to 3.13 per cent on 3 January, before falling back a little. This cost Treasury owners 16 per cent of their capital. Those who bought gilts at their peak are also nursing severe losses. But while many commentators agree that US bond markets at least will eventually experience an even greater correction, many still cling to the hope that other bond markets, as well as non-credit assets, will remain insulated from the looming storm.
So I’m grateful for M&G’s retail bond team for some fascinating number-crunching which shows why the bears are right to fear the worst. The great US bond market crash of 1994 saw US Treasuries lose just 10 per cent of their value, and the overall total return was just -3.45 per cent that year. The reason for this almost decent performance – it felt far worse at the time – is that yields’ starting point were much higher; even a smallish correction today would be immensely greater.
But the experience of 1994 was that while American bond markets were hammered, other risk assets – including in emerging markets – actually sold off even more heavily in reaction. The Bank of America Merrill Lynch emerging market debt index lost 15.33 per cent; and even more remarkably the MSCI emerging market equity index lost 8.67 per cent.
Nobody knows for sure how it will play out this time. Perhaps emerging markets are now deemed less risky than US bonds. Gilts would certainly be caught up in the fallout – and in any case they are horrendously over-valued also, with prices propped up by quantitative easing.
My guess is that money will pour into equities in most markets, pushing up their prices. This is undoubtedly one reason for the recent rally in stock markets. The S&P 500 rose very slightly in 1994. One can never accurately predict the timing of crashes. But those who believe that it is easy to forecast which assets will turn out to be safe havens amid the inevitable carnage is clearly deluded.
The authorities’ and transport companies’ reaction to the current, eminently predictable bout of snow has been better than it was in recent years. Many councils kept main roads relatively clean, though side roads were often neglected. But the progress hasn’t gone far enough. It is an outrage that so many trains and flights have been cancelled; the lack of information was appalling. Far too many schools shut unnecessarily, making it nigh-on impossible for many parents to work, jeopardising jobs, livelihoods and the economy.
This can’t go on. Transport companies must make more of an effort and adapt to the new normal – several days of snow every winter. Schools need to stay open. London is a modern, prosperous metropolis: a few inches of snow must never again be allowed to defeat us.
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