Almost nine years ago, Bill Gross looked in the mirror and asked himself: “Did the man make the epoch, or did the epoch make the man?” Or to put it more precisely: the decade-long trend towards falling returns, which he knew how to monetize like no other, was over. The magic of the “Bond Kings”, as he was called, with it.
Where long-term yields are headed is a burning issue once again today, on which trillion-dollar markets depend. Will the economy accelerate after Corona with more growth, higher returns and higher inflation? Or are we going back to the old normal of low growth, low inflation and low yields? The answer, which is subject to a high degree of uncertainty, could be: real yields are drifting sideways, but nominally they will seek a higher level.
At the moment, yields are extremely low in real terms, i.e. calculated after deducting inflation. Roughly calculated, they are minus five percent in the USA and in the euro area. It won’t stay that way. Because the central banks take countermeasures, inflation will fall and nominal yields will rise. The question is how far.
It is often said that huge investments are needed, especially for climate protection, which should boost real returns. This effect certainly plays a role, but it may be overestimated. Renewable energies are difficult to control because they are mostly dependent on the weather, but they are no longer very expensive. Perhaps fewer cars will be bought in the future, for example, because people are switching more to share or rental models. In addition, some emerging countries will have a great need in the future to prepare for climate damage such as floods, but do not have the financial leeway to invest. So there are reasons that real returns should remain contained.
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More inflation over time
At the same time, it may well be that inflation will level off at a higher level than it used to, if only because today’s upward jump is solidifying. In addition, the central banks could live with that because they would then no longer hit the zero limit so quickly with their interest rate policy. The financial sector thinks in nominal terms and can also cope with higher inflation. While savers are no better off than they were before when inflation and nominal interest rates are both higher, it’s not so obvious that they don’t get anything out of it. And governments usually don’t mind a little more inflation.
On the way to a slightly higher level of nominal yields and inflation, however, there may still be nasty surprises. Nominal yields are surprisingly low at the moment, even though the central banks have initiated the turnaround in monetary policy. They may start later if the markets sense that the central banks are serious. Then, if inflation falls at the same time or shortly thereafter, real yields shoot up quickly, dampening the economy and, in turn, spooking markets.
Therefore, potholes are to be expected on the way to the next normality.
More: Distribution problems are often behind inflation