LONDON (Reuters) - Ultra-low bond yields are an “overrated” indicator of weak growth and inflation in the future, the BIS said on Friday, warning that central banks should think carefully before easing policy in such an environment in case they’re driven even lower.
Economic convention holds that low and falling long-term yields are a sign that investors are anticipating lower growth and inflation, and a central bank policy response to try and turn that around.
But Hyun Song Shin, head of research at the Bank for International Settlements, reckons depressed yields are more a consequence of persistent demand for bonds from long-term and risk-averse investors like pension and insurance funds.
Shin’s remarks come as inflation and bond yields around the world are picking up from historically low - in some cases, negative - levels. Inflation in the euro zone, long around or even below zero, is now its highest in four years at 2 percent.
“Long-dated yields may be overrated as signals of what will happen in the distant future, especially during turning points in the rates cycle, when such guidance would be most valuable,” Shin said in a speech to the U.S. Monetary Policy Forum in New York on Friday.
“If monetary policy responds to lower market-implied inflation rates with further easing, it could add to the feedback loop created by long-term investors chasing yield,” he said.
Even with yields at ultra-low levels, these investors continue to buy bonds because they need the steady cash flow to match their long-term liabilities. The lower the yield, the more they are forced to buy even longer-dated paper, Shin said.
Policymakers should take this into account when deciding policy and be aware that cutting interest rates further could create a “vicious circle” of ever-lower yields and rates.
Benchmark 10-year euro zone bond yields fell to a record low -0.20 percent in June last year EU10YT=RR but snapped back to a one-year high of 0.50 percent in January. They were last at 0.30 percent.
Shorter-dated two-year yields, however, slumped to a record low of -0.95 percent last month EU2YT=RR, partly driven lower by the European Central Bank’s bond-buying purchase programme.
Shin’s remarks were based on the findings of a BIS study of German insurers’ portfolios. The study found a “substantial” increase in their holdings of long-dated bonds in the three years to march 2016.
Euro zone insurance firms had 7.3 trillion euros of assets in June 2016, and pension funds around 2.4 trillion euros, according to the BIS. While they held around 12 percent of euro zone government bonds at the start of 2014, they accounted for 40 percent of net purchases of bonds in 2014, the BIS said.
Reporting by Jamie McGeever; Editing by Toby Chopra