Record-low government bond yields now fully reflect a slowdown in economic growth over the next year, and upside is limited according to boutique bond house,  Kapstream Capital.

At the end of June, US 10-year bonds closed at 2.93 per cent, the lowest level in over a year, while two-year Treasuries plummeted to 0.6 per cent, the lowest yield ever, beneath even that reached following the collapse of Lehman Brothers.

“Unless the economic circumstances worsen significantly from here, we feel that the upside in owning G7 government debt is limited,” Kapstream said in an outlook issued yesterday.

“The rally over the past three months has been driven by fear as bond yields now fully reflect a slowdown in economic growth over the next year. Similar to what happened during the crisis, market psychology is currently driven by the adage ‘return of capital is more important than return on capital’.”

Sovereign debt is not playing a role in Kapstream’s current moves to bolster liquidity and reduce mark-to-market risk in its portfolios. Rather it has increased its cash holdings, reduced risk offshore and bolstered the overall quality of its portfolios.

Acknowledging that return of capital was virtually guaranteed when investing in government debt, the Challenger-backed boutique cautioned that sound valuation became essential when buying at low yield levels.

Citing a GMO history of 10-year US Treasury performance between 1871 and 2010, Kapstream said that bonds with a nominal yield of 2.8 per cent (lower than the prevailing yield today) had delivered a real return of just above zero.

 

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