In these days of technological revolution and the associated increases in productivity, one of the m...
In these days of technological revolution and the associated increases in productivity, one of the most crucial features of the new economic world is often overlooked. Governments and central banks have embarked on a course of extreme fiscal and monetary prudence, the like of which has never been seen before.
The introduction of the euro placed upon formerly delinquent administrations a heavy burden of fiscal restraint. Who would have predicted, in years gone by, that countries such as Italy, Spain or Greece would impose financially painful yet prudent measures on its people?
Indeed the overwhelming objective for politicians in some European countries was to deliver Emu entry whatever the cost, anything else would have led to political oblivion.
Even the UK, which many in this country would hesitate to group with the southern European states, only really moved into the new era of effective financial governance in 1997 when the Bank of England assumed the responsibility for setting interest rates.
Yet as fiscal rectitude becomes the norm within the world's major economies, budget deficits have started to shrink and turn into surpluses.
This has meant that governments have not had to issue so many bonds. Allied to this, effective monetary policy has led to periods of prolonged economic stability which has further swelled the coffers of national treasuries.
The US Treasury has already begun a series of buy- backs of its securities which could, together with redemptions, take $170bn out of the market this fiscal year.
At the same time, the UK gilt market will shrink by at least £10bn and that amount could be substantially increased by the proceeds from the sale of the new generation of mobile phone licenses currently being auctioned by the government. Similar auctions are likely to take place in the Eurozone. In this environment, government bonds may become quite rare.
This is, in fact, only half the story. Not only is there set to be a substantial reduction in the supply of government bonds, but the demand profile is changing as well.
The ageing population and advancement of medical science means retirees are facing the double jeopardy of longer retirement periods and fewer workers to fund them.
This means their objective has to be to fund their own lifestyles with assets which provide very high levels of capital security allied to adequate levels of interest.
Until recently, long-term government bonds provided the answer.
Unfortunately the price of such assets may be forced so high by the lack of supply and the increased demand that a sufficient level of income may no longer be available.
So what is the answer to the potential problem of permanently lower government bond yields? Not surprisingly, investors are turning to higher yielding assets. The new economy has made investment in these issuers more difficult. Not only has technology and globalisation made corporations more vulnerable to competition and event risk, but more companies are seeking funding through the capital markets thereby increasing the universe to be covered.
On top of this, governments have sought to distance themselves from some of the AAA issuers they have traditionally been associated with in order to preserve the status of government bonds and procure cheaper funding.
If the opportunities in the new bond markets are managed properly, an effective investment policy will mean that the dearth of government bonds will not have a detrimental influence on investors' wealth and ensure a prosperous future.
Geoffrey Lunt is European manager fixed income, Investec Guinness Flight
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