In most developed markets globally, especially in Europe, bond yields are at historic lows. The low yields are coupled with low inflation and sluggish growth that are occurring as a result of changing demographics and unsolved issues from the recent debt crisis.
What’s Inside?
In the eurozone, the core participants, such as Germany, are facing the lowest yields in their history. The slow economic growth and near-zero inflation are proving fatal for bond market participants. Although the real-term yields are still positive, the expectation for a rise in global bond yields has faded.
How Is This Article Useful to Practitioners?
The author notes that the current situation in most developed markets is similar to the observations required in the Fed model (i.e., equities are cheap if the earning yields are higher than the 10-year bond yield). The current earning yields for markets in Switzerland and Japan are near 3% and 2%, respectively, versus their bond yields of 1% and 0.6%, respectively.
Some economists and analysts believe that the economy has reached its peak for the current cycle, which began in 2009, whereas others think it is an era of a new neutral (i.e., real interest rates being zero may last longer than expected).
The only litmus test for the Fed model is that pension funds and insurance companies globally have lost interest in equities for regulatory and risk reasons and continue to allocate a majority of their portfolios to the bond markets, which will keep the bond yields lower for a prolonged time.
Abstractor’s Viewpoint
The author provides some startling parallels between current European markets and Japan’s lost era. In addition, the author suggests that the traditional Fed model may not work in situations like the current one because of regulations.