Some economists believe the world's most advanced countries are locked in what is known as secular stagnation, a long period of low growth. The bond market appears to agree.
Over the past three months, yields on government bonds have ticked downward across the developed world. On Tuesday, yields on 10-year German and Japanese bonds hit their lowest points in history, while the 10-year U.S. Treasury yield sank to its stingiest level since May, 2013.
The immediate cause for falling yields is the abrupt decline in the price of oil. That will lead to lower inflation, which makes the fixed payout from bonds more attractive to investors. As buyers bid up the prices for bonds, the yield on those securities fall.
Paul Dales of Capital Economics says the headline rate of inflation in the United States will be negative in January and could remain below zero for much of the year. German inflation, meanwhile, has sunk to a five-year low of only 0.1 per cent, and consumer prices in the euro zone may soon be in outright deflation for the first time since the financial crisis.
While the potential for falling consumer prices helps to make even ultra-low bond yields look tempting to investors, central bank attempts to juice growth are also helping to encourage bond buyers. In Japan, for instance, the government is committed to buying large amounts of its own bonds as a way to boost inflation and spur spending. The European Central Bank is rumoured to be contemplating a large-scale program of sovereign bond purchases that could be announced as early as this month.
Behind those efforts are growing worries about the outlook for global growth. One of the most compelling motivations for investors to lend large amounts of money for a decade at today's depressed rates – a mere 0.283 per cent in Japan, or 0.444 per cent in Germany – is if alternatives such as stocks or commodities appear to offer an even worse proposition.
Chief worries on investors' minds include China's slowing economy, Russia's imploding finances and Japan's recession. There's also the uncertain outlook for the euro zone, where a Greek election on Jan. 25 may lead to yet another showdown between the country and its international creditors. In a worst case, Greece might stomp out of the currency bloc.
By comparison, North America looks a beacon of stability. But there will still be winners and losers from lower long-term rates.
In Canada, where 10-year government bond yields have sunk more than a percentage point over the past year to 1.633 per cent, lower interest rates will be good news for borrowers, but less welcome for banks, which make money on the spread between what they pay depositors and what they charge borrowers.
The most recent fall in bond yields can be seen as evidence for the secular stagnation theory put forward by former U.S. Treasury Secretary Larry Summers. In a speech last year, he pointed to feeble economic growth since the financial crisis, and suggested that this weakness might become a semi-permanent situation for many developed nations. One consequence would be substantial declines in real interest rates as slowing population growth, growing inequality and a fall in the price of capital goods reduce the demand for borrowing.
Other economists are more inclined to view the recent slump in bond yields as a passing phenomenon, at least in North America. At Capital Economics, Mr. Dales argues that falling oil prices will prove to be a powerful economic stimulus. "A short period of deflation won't prevent the Fed from hiking rates this year," he writes.
For now, however, stock investors and bond investors appear to hold two distinctly different views of what lies ahead. Despite their falls of the past couple of days, stocks are still trading at levels that suggest expectations of decent to strong growth. Bonds, in contrast, are suggesting that investors should proceed with a high degree of caution.