Low gilt yields to remain "for years", says Barclays

10 February 2012 | By Beth Brearley

The rates of return on risk-free assets are currently negative on an inflation-adjusted basis in most developed countries, which has created an environment as abnormal as the equity bubble of the late 1990s, the 57th edition of the annual study shows.

However this is not due to low equity valuations, which are consistent with future returns in line with historic norms, but to the structural decrease in the supply of ’risk-free’ assets, a situation which is not likely to change in the next few years, the findings suggest.

Although equity risk premia - the difference between expected yields on equities and risk-free assets - have been high for the past decade, they have become more pronounced over the past year and are likely to remain high over the next few years irrespective of cyclical factors, the research predicts, meaning current valuations should not be perceived as extremely cheap.

“While positive outcomes such as a stronger economic recovery and a restoration of confidence in euro area sovereign debt would lift equity prices and reduce equity risk premia, risk-free yields are likely to remain low and equity premia high relative to historic norms for a number of years,” Larry Kantor, head of research at Barclays Capital says.

The study lists safe assets as predominantly being US government debt (excluding debt held by the Fed), direct debt and asset-backed securities issued by US government-sponsored agencies, privately issued mortgage-backed securities and the public debt of the large European governments. (article continues below)

According to the research, in 2002 the amount of safe assets available to the private sector (the difference between the net supply of safe assets and world international reserves) was equivalent to 35% of world GDP, while the projection for 2016 shows this gap to be about 12% of world GDP.

“To return to the early 2000s would thus require an increase in safe assets of roughly 20% of world GDP, which would be about 100% of US GDP,” the research team writes.

“Even if the ’safe asset shortage’ is half this size, it does not seem conceivable to us that it could be addressed by the US, or even the advanced economies as a whole.”

The solution, the study suggests, lies in restricting China’s ability to claim the existing stock of ’safe assets’, while making it a more prominent supplier of these assets.

“Given that this will not happen soon, it seems likely that the safe-asset shortage will be with us for some years to come,” the study concludes.

“It also suggests that the eventual opening of the Chinese asset markets and the development of an international role for the renminbi may be very powerfully linked to the historically anomalous international financial equilibrium.”

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