Warren Buffett is warning that the “pathetic” returns available to bond investors may encourage risky behavior.
“Bonds are not the place to be these days,” the legendary investor wrote in Berkshire Hathaway’s annual letter to shareholders, lamenting that the yield on 10-year Treasury bonds has fallen 94% since September 1981.
Interest rates have been set below zero by central banks in a handful of countries including Japan, and trillions of dollars have been printed. The idea is that doing so will encourage banks to lend and companies and governments to borrow, spurring recovery from the pandemic.
But that has pushed yields on government bonds to very low levels, wiping out returns for investors such as pension funds and insurers like Berkshire.
Yields on US government debt have risen sharply in recent weeks, reflecting expectations among investors that a robust economic recovery will take hold in the United States thanks to vaccinations and stimulus measures.
But yields are still low by historical standards, and what happens next with the bond market is very much up for debate. In his letter, Buffett leans on decades of experience to point out that low yields also come with plenty of risk.
“Some insurers, as well as other bond investors, may try to juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers,” said Buffett.
“Risky loans, however, are not the answer to inadequate interest rates. Three decades ago, the once-mighty savings and loan industry destroyed itself, partly by ignoring that maxim,” he added.
History lesson
The Savings and Loan Crisis, which kept US regulators busy for most of the 1980s, kicked off when inflation and interest rates both rose dramatically, wiping out thousands of the small mortgage lenders.
The Oracle of Omaha doesn’t offer a policy prescription in his annual letter. But he does suggest that he thinks low yields are here to stay for some time, despite the recent rise.
“Fixed-income investors worldwide — whether pension funds, insurance companies or retirees — face a bleak future,” he wrote.
Not everyone agrees: Some investors are worried that prices may spike later this year when the coronavirus recovery takes hold in the United States, pushing the Fed to hike interest rates sooner than expected.
But there are still two reasons why the Fed is unlikely to hike rates anytime soon, according to Neil Shearing of Capital Economics.
The first is a switch by the central bank to target average inflation of 2% over time, allowing for more flexibility. The second is that the Fed has a dual mandate to pursue full employment as well as price stability.
