Why bond yields will be low for the next decade

Over the next decade, 3.5 million people will reach retirement age — the biggest increase in that cohort in Canadian history. And that means trouble for the economy.

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That retirement wave comprises “nearly 1,000 [people] per day, every day, for 10 years,” says Jeff Waldman, head of Global Fixed Income and managing director at CIBC Asset Management. He’s co-manager of the Renaissance Short-Term Income Fund, an underlying fund in the Renaissance Optimal Portfolios.

“To put that in context, that’s like creating five cities the size of Winnipeg or Quebec City over the next decade, just full of new seniors.”

That demographic shift in Canada will hurt GDP, and by extension, investment yields.

“Assuming there’s no surprise increase in productivity, exports or immigration, the economic drag from retiring boomers is estimated at 1.25%,” he says. “That means that real GDP could be stuck at the low 1% range over the next decade. And that’s going to impact interest rates.”

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For instance, 10-year government bond yields will drop because they “tend to follow the direction of nominal GDP. Nominal GDP is real GDP plus inflation. And the last time 10-year government bond yields in Canada traded at 10% was in 1991, when inflation targeting [was introduced] as the mandate for the BoC.”

In the years since, inflation has hovered at 2%. “If we bring together changing demographics and their impact on real GDP and inflation, we see the downshifting to a low 1% range for GDP, and the BoC keeping a lid of inflation. So we shouldn’t expect 10-year government bond yields to spend much time above 3% over the next decade.”

Comparatively, 10-year government bond yields were around 6.5% after World War II. “So three is the new six,” Waldman warns. “And that’s going to impact how we manage bond portfolios. It’s going to impact our top-down strategy of duration, sector allocation and yield curve positioning, as slow growth and low inflation dominate the next decade.”

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Many securities will be impacted. “Real-return bonds look expensive; [that’s] expensive insurance given our inflation outlook. And floating-rate notes may be attractive to cash today, but investors shouldn’t expect yields to float much higher given our interest rate outlook,” says Waldman.

To combat low yield, “A healthy dose of corporate bonds is going to be needed, both investment grade as well as non-distressed high-yield.”

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The data behind the numbers

The aging population represents a headwind for the Canadian economy. But boomers were once a boon.

“Boomers were a tailwind for GDP in the latter half of the 20^th century, when real GDP averaged 3.8% from the 1960s all the way through to the end of the 1990s,” says Waldman. But, “since 2000, real GDP has averaged just 2.2%. It’s not a coincidence that in the year 2000, the leading edge of the boomers was hitting age 55 and starting to leave the workforce.”

And things will get worse.

“The support ratio, the proportion of working-age people to retirees, [is] going to drop from 3.9 workers per retiree today, to 2.8 workers per retiree in 2025.” When the CPP was introduced in the 1960s, that ratio was 7.1 workers per retiree.

“This is going to be the biggest drop in the support ratio over a 10-year period in our nation’s history. And people 65 and older are going to comprise 21% of the population a decade from now, compared to just 16% today.”

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Waldman also points out that seniors tend to spend less — and when they do, they spend on services as opposed to goods.