I had a conversation with a fellow trader yesterday. I said that I preferred short stocks as opposed to long bonds as my risk-off vehicle of choice to play recessionary concerns in the U.S. He said, “Of course! Bond yields can’t go much lower!”
The 10 year yield is at 1.5% in the U.S. A year and a half ago, it was 3.75%. What a move. And I’ve also read all those articles about 10 year yields at all-time lows, with traders and pundits pitching short bonds as the contrarian trade of the century. But I’m not so sure. Here I present my main evidence, the chart of the Japanese 10 Year Government Bond Yield over the last 20 years (actually since 1993 due to data issues, but general idea the same):
Japanese 10 year yields have traded between 0.45 and 2.00% over the last 15 years. In that period, Japanese government debt has actually soared as a % of GDP, but that has not spooked the government bond market. There are numerous potential explanations for this, but regardless of the explanation, the evidence is quite clear. Government bond yields of even deeply indebted governments can stay low for a very long period of time.
The Japanese example is part of the reason why I have a hard time being a contrarian seller on bonds. In my view, Japan is a good example of what happens when bad debt is not destroyed, but propped up. I think banking systems throughout the developed world now face a similar fate, the U.S. included. Financial repression of savers (i.e. very low interest rates) is a way to prop up banks over a long period of time, but it has adverse consequences in other parts of the broader economy. It seems like that’s the path global policymakers have chosen. If so, then expect low rates to continue for many, many years.