By the FT’s Chris Flood
Government bond markets are facing a decade of “disastrous returns”, according to Tim Bond, head of asset allocation at Barclays Capital.
Bond reckons unfavourable demographic trends mean long term-yields in the US and UK will double from current levels over the next ten years, moving up to around 10 per cent by 2020.
In its 2010 Equity Gilt Study, Barclays said its analysis of the interaction between demographic trends and bond yields suggest the era of low and stable long-term interest rates is over.
Effectively, the models are suggesting that the shrinkage in the high savings population cohorts and an expansion in the retired population will alter supply demand dynamics in the debt capital markets in a profoundly negative manner.
Ageing populations will lead to an explosion in government debt over the long run:
The unfavourable shift in dependency ratios, combined with sharply increased spending on pensions and healthcare is likely to cause a sustained deterioration in primary fiscal balances and a continuous increase in government debt to GDP ratios.
IMF and OECD projections suggest that the effects of ageing alone will increase debt ratios by 50 percentage points of GDP over the next 20 years:
For the advanced G20 economies, the government debt/GDP ratio is projected to rise from 100% in 2010 to 150% in 2030. Over the subsequent 20 years, debt ratios for these countries are anticipated to rise further, increasing to 275% of GDP by 2050.
And of course the deterioration in government finances — as a result of the credit crisis — has worsened the starting point for the future path of rising indebtedness due to demographic factors:
The deterioration in budget deficits has also provided a notable setback to many countries’ strategies for dealing with the long-run effects of aging. Although fiscal discipline has been weak in the US and UK over the past decade, the larger European economies had certainly been following fiscal policies designed to reduce deficits in the short run and thus clear the decks for the anticipated increase in borrowing over the long run. This strategy has now been de-railed by the widening of deficits stemming from the credit crisis.
Mr Bond says it is difficult to avoid the conclusion that national savings within the advanced economies will be insufficient to meet domestic requirements:
The common assumption that future savings flows from the large developing economies will be a ready source of finance for the ageing advanced economies is most probably flawed. The projected trajectory for old age dependency ratios in countries like Brazil, China or Russia are as severe as in the US. It is highly implausible to believe that Africa, the Middle East and India will be capable of funding the rest of the world’s growing population of retirees.
Because the rise in old age dependency ratios is common to virtually all significant economies, the idea that a redistribution of global savings flows from surplus to deficit nations might mitigate the impact of ageing on bond markets is a false comfort.
Barclays also says the risk premia embedded in nominal bond yields is likely to rise, as history shows that higher inflation – sometimes hyperinflation – can be the end result of unsustainably high debt/GDP ratios.
Although such an outcome is by no means an historical inevitability, it is certainly the case that high debt ratios increase the temptation for policymakers to engineer higher inflation as a soft option for containing debt/GDP ratios.
Pragmatically, we can take the view that when investors focus on the nearubiquitous trend for substantial increases in debt burdens, they will demand a higher longterm inflation risk premium.
Mr Bond admits that a decade of rising bond yields as forecast by Barclays demographic models appears unlikely from our present, deleveraging, post-crisis perspective, and notes that past few years have been characterised more by an abundance of savings relative to productive investment opportunities.
However, it is likely that this phase represents a high-water mark, to be followed by an inexorable turn in the demographic tide. Over the next two decades, the boomer generation will age into retirement and run down their accumulated savings. An era of capital abundance will gradually turn into an era of capital scarcity. Government debt burdens will rise sharply, with the risk premium demanded for financing these debts increasing as private sector net savings flows dwindle. Given the broad international context for these trends, with similar developments afflicting almost all the world’s major economies, the means by which the government debt burdens are eventually curtailed is unclear. As a result, government bond yields are likely to require a significant rise in risk premia to cover the eventuality of default, either outright or through inflation.