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Affluent Christian Investor | July 7, 2020

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Visualizing The Near-Zero Bond Yield Problem

With contributions by Charles Bowyer.

In response to the recent record-setting market volatility, the Federal Reserve has responded with ramped up monetary stimulus, including cutting the Fed Funds rate, and as of this writing, beginning an “unlimited” quantitative easing program. As the Fed pushes down interest rates, it’s worth keeping in mind that we were already at historic lows for bond yields. According to a report by Visual Capitalist on historical interest rates, bond yields have been generally declining for over 700 years.*

(Source: VisualCapitalist)

In the West, we’ve experienced a dramatic downward trend in the yields of government bonds. The trend extends back nearly 700 years, and as you can see in the cluster of purple dots on the far right of the chart (representing US Treasuries), it’s only accelerated in recent times. What this chart shows is that, despite occasional and brief spikes in interest rates, the trend has been moving towards lower and lower yields.

As time has gone on, the investor turning to bonds has been getting less and less back per dollar invested.

Now, one could argue that the 700-year trend doesn’t really matter, and that instead we should focus only on interest rates in the recent past. Fair enough. Let’s look at what’s happened since the end of that chart. Statista recently reported on the Federal Reserve’s attempt to “shield the economy” by cutting interest rates further. **

Rates were at over 5% (still very low by historical standards) before the Great Recession in 2007. Then the Fed slashed them dramatically to deal with that crisis and kept them at near 0% for years. We had a very brief period of rising rates, which never even reached 3%, before the slash to deal with this crisis. The Fed’s recent actions follow the historical trend of declining interest rates.

Let’s take a look at another potential investment that shares some characteristics with bonds: real estate.

The chart above shows the historical returns as of end of January 2020 for REITs (represented by the FNRETR Index in blue), bonds (represented by the Barclay’s U.S. Aggregate Bond Index in grey), and the S&P 500 (in orange).

With the sole exception of the 20-year time frame, REITs are performing in between bonds and the S&P. There’s a reason for that: REITs resemble bonds in that their value comes from what is essentially a kind of fixed income, in the form of leases. The payments from leases constitutes their cash flow – they’re similar to a fixed income vehicle. Similarly, if you buy a bond, the debtor is required to provide a fixed payment on a pre-determined basis to you. In the dataset represented by the chart above, REITs were behaving in between the S&P and an aggregate bond index, because their characteristics sit somewhere between these two asset classes.

In times of economic turmoil and panic, investors are looking for sources of yield.

Next time, we’ll directly compare the yields that bonds are currently offering to the yields offered by REITs.

* Source: “Visualizing the 700-Year Fall of Interest Rates,” February 2020, VisualCapitalist.com
** Source: “Fed Slashes Rates to Shield Economy From Pandemic,” March 2020, Statista.com

 

 

Originally published on Townhall Finance.

 

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