Bond yields and geopolitics: two problems investors face

Terry Tanaka says investors formed their idea of "normal" under conditions that are now shifting, from bond yields to geopolitical tensions.

Investors constantly contend with bond yields and geopolitical events. The difficulty is noticing how those forces surround us and quietly influence our thinking until they fade into the background.

David Foster Wallace repeats an old parable in *Infinite Jest*. Two young fish swim past an older one, who calls out, "Morning, boys. How's the water?" They keep going. Then one fish turns to the other and asks, "What the hell is water?"

Bond yields are climbing quickly

Ten-year gilts have reached 5.4%, while ten-year Treasuries stand at 5.2%. German and Japanese yields have also hit their highest levels in two decades. Those rates look attractive to many investors, but the fact that bonds are still trading at these yields suggests that large amounts of money have yet to return.

To judge whether bonds offer good value, start with the forces behind higher yields. Are investors pricing in faster inflation, concern about government finances, a larger supply of long-term corporate debt, or stronger growth pushing up short-term rates? There is another possibility: our idea of what counts as normal may be skewing the comparison.

Ten-year gilt yields now sit well above the 3.3% average recorded since 2000. That comparison needs context: central banks kept yields unusually low for much of that period. Many analysts and fund managers formed their views during those years, so 5% can feel both extreme and impossible to sustain. Go back further, though, and the comparison shifts. The average since 1980 was 6%, rising to 6.9% since 1960, a period that includes the inflationary 1970s. Whether today's yields look exceptional, then, depends on which history you treat as normal.

UK ten-year gilt yields

When does geopolitics matter?

In a recent seminar, an experienced institutional investor took the opposite view: geopolitics, he argued, does not matter. Markets may react when events occur, but he said those reactions seldom last.

Most of today's investors have spent nearly all their careers in the post-Cold War period, shaped by the stability it brought to trade, security, and capital markets. Against that backdrop, individual shocks were usually temporary disturbances within a fairly steady system. That system has now changed: we are living under a different geopolitical regime, and the consequences will follow.

We'll examine the implications at our BFIA Wealth Summit in London on Friday, 6 November. The parable has a sharper ending than it first suggests: a fish discovers what water is only when a fisherman's hook catches it. Investors would rather not learn the same way.