Back Through the Looking Glass
Why, sometimes I’ve imagined as many as six impossible things before breakfast
In order to remain sane as TEAM fixed interest investors, it sometimes helps to have the open-mindedness of the White Queen.
When 10 Year German Government Bond yields fell to minus 0.7% in August 2019, most rational investors including TEAM felt we had gone as far through the mirror as it was possible to go. Paying a borrower, even one as fiscally prudent as the German Government, to take one’s hard earned money looked like a proposition from the ‘magic beans’ end of the business swamp. Even more so, given that the German economy was ‘powering ahead’ at a startling annualised growth rate of 0.7% at that point in time.
Fast forward to early March 2020, and as realisation of the seriousness of the COVID-19 outbreak became apparent, Government yields once again fell as investors sought any safe haven, the 10-year Bund falling to a new record low yield of -0.86% on the 9th March. At that point, with most other asset classes tumbling in response to stories of an impending social and economic catastrophe spilling from every media orifice, it very roughly, on the back of an envelope, made sense. Paying the Federal Republic of Germany nearly 1% per annum to borrow your money for 10 years seemed a reasonable cost. (A bargain even, in the context of those paragons of stable governance, the Kingdom of Spain, who would have paid a munificent 0.2% per annum for your money for 10 years at the same point in time).
And that is where the real pain in the trade began. Rather than acting as a safe haven away from the equity and corporate bond market carnage, Bund yields began to climb on the 10th March, and did so for nine straight days to peak at -0.2% on the 19th March. That was the day when the ECB woke up, and decided that, given the liquidity freeze in nearly every other asset that was leading investors to raise cash from the only asset where there was a firm bid, Government bonds, that perhaps concerted Central Bank assistance might be needed. In price terms, the on-the-run 10 Year Bund fell from 109 to 102 during those nine days, a drop of 6.4% in, lest we forget, one of the world’ most secure assets, on which you were earning a yield of -0.86% if you’d bought it only 9 days earlier.
Now of course in typical Alice in Bond World fashion, that is not the whole story. In a post financial crisis environment, where, for TEAM and other fixed interest investors at least, small numbers really matter, we’re forced to consider the concept of ‘Real’ (i.e. post inflation) as well as ‘Nominal’ (what it says on the tin) yields.
If we take August 2019’s Nominal Bund yield of -0.7%, and deduct EU CPI inflation at that point of 0.8%, we get a Real yield of -1.5%. (A loss of 0.7% in yield, and a 0.8% erosion in purchasing power for every Euro invested). Taking Mar 2020’s low yield point of -0.86% and adding in CPI inflation for March of 0.3% gave a Real yield of nearly minus 1.2% at that point.
10 Year Bunds presently yield -0.4%, whilst 10 Year Gilts are at 0.2%. Hardly the easiest of starting points for arguing in favour of your asset class at any asset allocation meeting. However, in a world of chaotic swings in equity and commodity markets, and in the true spirit of looking at the world from the other side of the mirror, we at TEAM recognise the surprising effects the latest Consumer Price Inflation data from the UK (CPI of -1.6%) and the EU (-3.6%) will have upon on Real Bond yields. Who would have thought simply getting (most of) your money back could be so enticing?
Next week, what can Humpty Dumpty teach us about asset allocation? (Maybe).