Extraordinary Government Bond rally

Bonds(from the Quest March 2015 Quarterly Report) The quandary for market observers is whether the market is cheap or expensive given the recent rally in markets. Each argument has some validity. Price earnings ratios for many stocks are well above the average of the last two decades. Conversely, equity earnings yields continue to look attractive when compared to falling long term interest rates. Global interest rates are now at unprecedented levels; for instance German 10 year government bond yields have fallen dramatically over the last five years.

Investors are now happy to earn an interest rate of only 0.14% pa for holding German government paper over 10 years; the lowest level on record.  This fall has been mirrored in all European bond markets and its impact is now being transmitted to the rest of the world in one manner or another. For example, 70% of Euro ‘investment grade’ (a high quality rating) corporate bonds now have yields less than 1%. Further, investors have pushed sovereign debt into negative yields for German, Dutch, Austrian, Irish, Swedish, Finnish, French, Belgian and Swiss bonds.

Domestically, despite the fact mortgages can now be taken out at interest rates of less than 5% for the first time since the early 1960’s, many expect the RBA to cut rates further. Like elsewhere, this cheap finance is driving up asset prices, particularly equities and eastern seaboard housing.

This is the primary motivation for authorities to undertake Quantitative Easing. QE delivers asset inflation which should lift aggregate wealth and ultimately stimulate investment and consumption.