With hindsight, one of the best trades of the year was very
simple. An investor could have turned up on Jan. 2, loaded up on long-dated
eurozone, U.S. and U.K. government bonds—and then spent the rest of 2014 doing
whatever they liked. Returns have been spectacular. In the eurozone, bonds with
20 years or more to maturity have gained 34%. Meanwhile, U.S. and U.K. bonds
with 25 years or more to run are up 27%, according to Barclays indexes.
Thirty-year yields have fallen by more than one percentage point.
Yet, going into 2014, the script called for quite a
different outcome. Belief that yields would rise was almost universal at the
start of the year. Despite being wrong, it is now the view of many forecasters
for 2015.
But the picture for next year is complicated. In the
eurozone, tensions around the Greek elections may cause some volatility and a
flight to safety; 10-year German yields hit a new all-time low below 0.55% this
week.
Bigger questions surround the European Central Bank on
whether and how it might purchase eurozone government bonds, and what impact
that might have on wider markets. Meanwhile, it is yet possible that ultralow
European yields help keep a lid on those in the U.S. even as that economy picks
up steam.
On top of this, inflation has been dropping like a stone,
boosting the allure of bonds, particularly to aging populations that don’t want
the volatility of equities. Data released Tuesday showed Spanish inflation fell
to negative 1.1% in December and eurozone headline inflation seems likely to
turn negative. In the U.K., inflation in November was 1% versus 1.9% as
recently as June. And in the U.S., the pace of price rises has slowed to 1.3%
from 2% at the midyear point.
Oil prices are largely responsible for this. Normally,
central bankers would regard that as a transitory change that is good for
growth. But, six years on from the collapse of Lehman Brothers, the situation
is still not normal. Central banks wary of stifling recovery may yet err on the
side of caution. Just look at the U.K.: As recently as June, investors still
thought the Bank of England might lift rates in late 2014. Now many expect
takeoff only in late 2015.
Higher U.S. yields hinge on the Federal Reserve starting to
raise rates. Two-year yields have started to rise; they have roughly doubled
since the start of 2014. The latest data suggest the U.S. economy is motoring.
But even if the Fed does start to raise rates, that doesn’t necessarily mean
sharply higher long-term yields, particularly since rates are likely to rise
only gradually, and top out lower than in the past.
Mathematically, a rerun of 2014 is unlikely; yields are
already extremely low. But with uncertainty persisting about growth and
inflation, those betting on higher yields may yet have to be patient.
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