What do falling bond yields mean for investors?

How the market values government bonds can tell us a lot about our economy. Global bond yields are currently at historic lows, and while it’s tempting to look at the storm clouds, there is also plenty of positives to take away.

Governments issue bonds to raise funds to pay for infrastructure projects and expenses in running a country. Investors buy these bonds from governments and receive periodic interest payments, as well as repayment of the principal when the bond matures.

“Falling government bond yields typically imply expectations of weaker economic growth,” says Dr Sam Tsiaplias, an academic at the Melbourne Institute of Applied Economic and Social Research.

Although bond yields historically have represented a collective view on growth and inflation, Tsiaplias believes that the state of the bond market has more to do with concerns about global economic trends.

“Longer-term bond yields have been low for several years. A common view is that this is a function of growing uncertainty about the timing of a global economic recovery…”

Before the global financial crisis in 2008, yields on long-term Australian government bonds averaged around 5.5 per cent. Since then, yields on 10-year bonds have fallen to record lows of two per cent in 2016 and 1.5 per cent in 2019. Australia’s falling bond market has been seen in most Western economies, as investors have moved their money to lower risk assets.

One key factor in the uncertainty is a potential trade war brewing between the world’s two largest economies, the United States and China. Some economists fear that Australia could face consequences of a trade war between two of our closest trading partners.

“The imposition of tit-for-tat tariffs between the US and China is obviously not beneficial for the Australian economy,” Tsiaplias says.

“If the trade war is protracted it will probably dampen Chinese demand for Australian commodities thereby reducing exports and hampering economic growth.”

Some market analysts have predicted that the yield on Australian 10-year government bonds could fall below 1 per cent by the end of this year. The Australian Financial Review believes that this is because investors are growing “more confident that the Reserve Bank will eventually turn to unconventional monetary policies to shore up economic growth.”

Indeed, falling bond yields are attracting the attention of Central Banks around the world, who may seek to cut interest rates to help stimulate the economy.

“The intention is that consumers will respond to rate cuts by increasing their spending. Lower interest rates also make it cheaper for firms to invest although there is a lot of contention about the extent to which investment hurdle rates actually respond to cuts in the cash rate.”

Tsiaplias says that the most likely result of lower bond prices is that they will tend to make alternative asset classes more appealing.

“The more uncertain outcome is whether lower rates stimulate consumer spending, thereby pushing up earnings for stocks in consumer-sensitive areas such as retail.

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