The End of the Yield Famine is Far Away - Dr Lacy Hunt

[Midpack]

With about 40% of my AA in (short duration) bond funds, clearly I believe bonds are better than cash/CDs for at least a few years (2014-15 before it's time to find the exits), but on this reasonable people can certainly disagree (and have here).

But I sure hope the "yield famine" isn't as protracted as this economist suggests, but who knows. Sheeeeeeesh...

How long can this low interest rate siege last?

Borrowers will love his answer to the question. Savers will be troubled. Flipping through one of his chart collections, Dr. Hunt comes to a chart that overlays the history of interest rate declines after major financial panics. If the future replays such past events, it takes about 14 years for interest rates to hit bottom. Since our last financial debacle was in 2008, that suggests interest rates may continue falling until 2022. Yes, savers, you read that right: 2022.

And when that happens, the same data shows that long-term government bond yields will bottom at about 2 percent, compared to their current rate of 2.9 percent. Even 20 years after financial disasters like 2008, interest rates are only about 2.5 percent.

Savers are facing a yield famine that could last beyond 2028. And borrowers who just refinanced their homes at 3.5 percent may have yet another opportunity to reduce their mortgage payment.

AssetBuilder - Lacy Hunt: The End of the Yield Famine Is Far Away - AssetBuilder Inc., Registered Investment Advisor

 

[heeyy_joe]

IMO that could be true as that fairly matches up with the biggest birth years of boomers hitting retirement. This is most likely when we will see too many dollars chasing too few goods, which is the basic recipe for inflation.

 

[Live And Learn]

I should know this .... but .... do bond yields and inflation tend to match ? for some reason I think they do. In that case, as long as bond yields > inflation rates we should be good, no ?

 

[Ready]

I suspect he is more right than wrong. I don't see interest rates rising substantially in the next few years. I have most of my bond allocations in medium term (5-6 year duration) municipal bonds. They are yielding 3% tax free, which seems like a better deal than most other short/medium term bonds out there. I'm not that worried about the fund NAV going down drastically, as I don't see rates rising more than 1% a year at best. So if the NAV goes down 5% in one year, but I get 3% in dividends, I may lose about 2%. Compare that to the worst case in equities, where we have seen drops of 20-30% twice in one decade, and it still makes bonds look pretty attractive.

 

[clifp]

I should know this .... but .... do bond yields and inflation tend to match ? for some reason I think they do. In that case, as long as bond yields > inflation rates we should be good, no ?

Well yes and no. In the long term yes. But remember as rates rise the value of your bond portfolio drops, and the drop in the value will typically more than cancel out the benefits of higher coupon rate.

So for example you have 50/50 portfolio with 500K in Vanguard Total Bond Market. Interest rates and inflation rise 2% over a short period of time (<1 year). You'll collect roughly 13k in interest from the fund, but the value of the fund will drop roughly 10% (duration is 5.19) or 50K.

If interest rate remain flat, next year the fund will deliver and additional 10K in interest, but it will take 5 years to break even from the additional coupon payments.

Finally is worth considering the increase impact on taxes as rates rise.
For example if interest rates are 2% and inflation is 0. If you are in the 25% federal bracket and 5% state. Your real after tax return is 2% -30% tax*2% - 0% inflation =1.4%

If real rates remain at 2% but inflation rise to 8% (like it did in the 70s and early 80s), interest rates will be 10%. But your real after tax return falls dramatically. 10% - 30%*10%- 8% inflation = -1% real return.

In summary inflation is really really bad for bonds holders, it is even bad for TIPS holders.

 

[FANOFJESUS]

With about 40% of my AA in (short duration) bond funds, clearly I believe bonds are better than cash/CDs for at least a few years (2014-15 before it's time to find the exits), but on this reasonable people can certainly disagree (and have here).

But I sure hope the "yield famine" isn't as protracted as this economist suggests, but who knows. Sheeeeeeesh...

AssetBuilder - Lacy Hunt: The End of the Yield Famine Is Far Away - AssetBuilder Inc., Registered Investment Advisor

But rates started going down in 1981 not 2008. They sped up in 2008 but that is not where they started.

 

[clifp]

I suspect he is more right than wrong. I don't see interest rates rising substantially in the next few years. I have most of my bond allocations in medium term (5-6 year duration) municipal bonds. They are yielding 3% tax free, which seems like a better deal than most other short/medium term bonds out there. I'm not that worried about the fund NAV going down drastically, as I don't see rates rising more than 1% a year at best. So if the NAV goes down 5% in one year, but I get 3% in dividends, I may lose about 2%. Compare that to the worst case in equities, where we have seen drops of 20-30% twice in one decade, and it still makes bonds look pretty attractive.

As you can see by this chart 10 year treasury averaged more than 1% rise per year from 1971 on, and shot up 7% in a 2+ year period from 78 to early 1980. After taxes,inflation, and falling bond price an intermediate term bond holder in the upper middle class ($32,000 household income in 1971) would have lost roughly 80% of his money during that decade.

 

[HighRoller]

And who do we have to thank for this?

 

[haha]

I should know this .... but .... do bond yields and inflation tend to match ? for some reason I think they do. In that case, as long as bond yields > inflation rates we should be good, no ?

Wonderful theory, but clearly not true in the age of financial repression. Just have a look at the negative yields on TIPS. Guaranteed real loss.

Ha

 

[rbmrtn]

Dr Hunt as some very good commentary on deflation/inflation. The archives can be found here.

Economic Overview

 

[kmt1972]

From a historical point of view we are in a famine. What I did was to take the average difference between the Bloomberg 12 month CD and CPI for every year since 1997 and I got

1997 +3.5%
1998 +3.9%
1999 +3.6%
2000 +3.5%
2001 +0.8%
2002 +0.6%
2003 -1.1%
2004 -0.5%
2005 +0.6%
2006 +1.9%
2007 +2.4%
2008 -0.7%
2009 +2.1%
2010 -0.8%
2011 -2.3%
2012 -1.3%
2013 -1.5% YTD

2009 was positive only because CPI was negative. The 2001-2003 recession did lead to negative after inflation CD rates but it was heading to positive territory in 2005. We pretty much are in negative territory since 2008. I think unemployment has to fall to 6% for this financial repression to stop. Should be a couple of more years I fear. I suspect the golden years of late 1990s will not come back in a long time, if ever.

 

[daylatedollarshort]

From a historical point of view we are in a famine. What I did was to take the average difference between the Bloomberg 12 month CD and CPI for every year since 1997 and I got

1997 +3.5%
1998 +3.9%
1999 +3.6%
2000 +3.5%
2001 +0.8%
2002 +0.6%
2003 -1.1%
2004 -0.5%
2005 +0.6%
2006 +1.9%
2007 +2.4%
2008 -0.7%
2009 +2.1%
2010 -0.8%
2011 -2.3%
2012 -1.3%
2013 -1.5% YTD

2009 was positive only because CPI was negative. The 2001-2003 recession did lead to negative after inflation CD rates but it was heading to positive territory in 2005. We pretty much are in negative territory since 2008. I think unemployment has to fall to 6% for this financial repression to stop. Should be a couple of more years I fear. I suspect the golden years of late 1990s will not come back in a long time, if ever.

Interesting table. Thanks for posting. I am hoping for a 1% average return over inflation for our retirement plan.

 

[ERhoosier]

But rates started going down in 1981 not 2008. They sped up in 2008 but that is not where they started.

Exactly what I was thinking. Macro decline in rates started back in early '80's. And economic conditions affecting interest rates have differed so much over the decades that I find it hard to Hunt's theory. Not saying I know where rates are headed over next few yrs, but my suspicion is another 12-24mo of bottoming around current levels then an increase that likely will not keep up with where inflation is going

 

[Khufu]

Not saying I know where rates are headed over next few yrs, but my suspicion is another 12-24mo of bottoming around current levels then an increase that likely will not keep up with where inflation is going

The inflationistas are apparently the modern Millerites. No matter how consistently their predictions of inflation and penalty rates to finance the national debt have failed to appear since the financial crisis their faith that doom must be just around the corner remains unshakeable. It couldn't possibly be that the economic model that is rattling their brains is just wrong.

 

[kmt1972]

Interesting table. Thanks for posting. I am hoping for a 1% average return over inflation for our retirement plan.

Thanks. My plan is for 0.75% return above inflation. Hopefully when we retire 4 years from now this financial repression would be mostly over. I would love for CDs to return 3% over inflation. I suspect that I would have to invest in some equities plus fixed income just to get 0.75% return over inflation.

 

[MooreBonds]

Exactly what I was thinking. Macro decline in rates started back in early '80's. And economic conditions affecting interest rates have differed so much over the decades that I find it hard to Hunt's theory. Not saying I know where rates are headed over next few yrs, but my suspicion is another 12-24mo of bottoming around current levels then an increase that likely will not keep up with where inflation is going

While rates "started down in the early 80s", is the massive all-time high rates of the late 70s/early 80s really a good point to start from?

Looking at a chart of 1 year rates starting in the late 1800s, 1 year rates cycled from lows of about 2% to a high of about 5% for almost 100 years, then spiked in the late 70s/early 80s to roughly 3 times what the previous average/highs had been!

Given that was such a huge spike, I would throw those data points out the window and only start the clock when rates finally moderated back down to something resembling historical averages (early-mid 90s), rather than starting in the early 1980s.

 

[bjorn2bwild]

According to Matt Taibbi there will need to be a few more prosecutions before interest rates rise.


Everything Is Rigged: The Biggest Price-Fixing Scandal Ever



The Biggest Price-Fixing Scandal Ever | Politics News | Rolling Stone

 

[samclem]

The inflationistas are apparently the modern Millerites. No matter how consistently their predictions of inflation and penalty rates to finance the national debt have failed to appear since the financial crisis their faith that doom must be just around the corner remains unshakeable. It couldn't possibly be that the economic model that is rattling their brains is just wrong.

Buy long bonds if you want. It's far too soon to know how this story turns out. US currency strength (for now) has much to do with the comparative weakness of Europe. And inflation is as close as a return of the normal velocity of money--all that cash is waiting to do plenty of damage.
Or, we can follow Krugman et al: "Ben, crank up the helicopter, er, presses, let's pay off this debt with Confederate Currency! There's no chance the bond market will react--we're bulletproof!"

 

[pb4uski]

I should know this .... but .... do bond yields and inflation tend to match ? for some reason I think they do. In that case, as long as bond yields > inflation rates we should be good, no ?

In theory, current bond yields would reflect expected inflation + credit risk + liquidity risk, etc. so in theory current bond yields would exceed inflation.

See Wikipedia - Market interest rates

 

[Ready]

As you can see by this chart 10 year treasury averaged more than 1% rise per year from 1971 on, and shot up 7% in a 2+ year period from 78 to early 1980. After taxes,inflation, and falling bond price an intermediate term bond holder in the upper middle class ($32,000 household income in 1971) would have lost roughly 80% of his money during that decade.

Interesting, but I don't follow how a bond holder would have lost 80%. If they owned individual bonds they would have been repaid their principal at maturity. If they owned bond funds, then a fund with a 5 year duration would be replacing about 20% of its holdings each year, and with rates rising so fast, the replacement bonds would have a higher yield, offsetting the reduction in NAV. After five years, all of the lower rate bonds would have been flushed out.

In addition, we have to pay attention to the rise in rates as a percentage of the current rates. When rates shot up 7% in two years, the current rates were much higher than the almost zero rates we see now. In proportion, it was not as significant as if the current rates went from near zero to 7%, which I still say is highly unlikely.

 

[Midpack]

Too bad I didn't pay attention to or fully understand bonds around 1980...though fortunately equities did well also for the most part.

 

[samclem]

Too bad I didn't pay attention to or fully understand bonds around 1980...though fortunately equities did well also for the most part.

Don't beat yourself up. The CPI in 1980 was 13.51%, so even at these bond rates the government bonds were net losers. And if we think back to the mood of the country at the time, things looked pretty gloomy. If bond rates ever go really high again it will be during a similar period of great uncertainty and probably high inflation, it will take an optimistic, contrarian spirit to dive in for the long term under such circumstances. And, as you point out, stocks did pretty well.

 

[audreyh1]

But rates started going down in 1981 not 2008. They sped up in 2008 but that is not where they started.

That's what confused me too - 1981 would be the year.

Never mind - he's talking about after major financial crises, like 2008.

For the record - most of my bond funds are intermediate duration.

IMO, the warnings of near term rises in interest rates have been greatly exaggerated, and I think deflation is at least an equal risk.

I figure we're in for a long bottoming process.

 

[foxfirev5]

Other than reversion to the mean I can't really see any reason why interest rates will rise for the foreseeable future. The gov't really needs to keep rates low to finance the debt. I have a feeling that savers would quickly grab an increase in yield which should keep the rates suppressed as well. However these are basically just hunches since I don't have an accurate picture of the macro situation out there.
My own plans count on a zero real return for bonds and maybe a 1-2% real return for equities.

 

[Midpack]

IMO, the warnings of near term rises in interest rates have been greatly exaggerated, and I think deflation is at least an equal risk.

I figure we're in for a long bottoming process.

And coincidentally, Dr Hunt agrees with you there too. http://www.hoisingtonmgt.com/pdf/HIM2013Q1NP.pdf