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Low yields forever

Such low expectations aren't confined to the UK. In the US, markets expect five-year real yields to be only 0.6 per cent in 2021. That's well below their pre-crisis levels.

These expectations tell us that negative real yields aren't simply due to the shock of Brexit or to the near-term economic slowdown this will cause. Instead, they are a long-term global phenomenon. Real yields have been trending downwards since the late 1990s. If there's a bubble in bonds, it's the longest-lasting one in history.

More likely, there is no bubble. Instead, negative real yields reflect longstanding structural problems in the world economy - problems which are causing slower growth.

Most economists agree that there's a close link between expected economic growth and real yields. One reason for this is that if people expect their incomes to stagnate they'll be less willing to borrow and this reduced demand for funds will lower interest rates: fancier versions of this invoke intertemporal substitution and Euler equations. Less formally, if investors anticipate slower growth they'll want to avoid growth-sensitive assets such as equities and will switch instead to safer assets such as bonds, thus reducing their yields.

So, why might expected growth have fallen around the world? There are three big reasons.

One is slower growth in world trade. There are many reasons for this - among them companies realising that long supply chains are unmanageable; a reduced confidence that future finance will be forthcoming; and an ending of the big tariff cuts we saw in the early 00s. Whatever the reason, though, the effect is the same. Lower trade growth means lower output growth because firms specialize less and face weaker incentives to increase efficiency to fend off foreign competition. As Adam Smith wrote, "the greatest improvement in the productive power of labour... seem to have been the effects of the division of labour". A slowdown in the international division of labour thus means slower productivity growth.

Secondly, there's weaker capital spending. Again, there are many reasons for this: my favourite is that firms fear future competition from better technology. But whatever the reason, the effect is the same. Lower investment means weaker growth partly simply because it reduces aggregate demand growth, and partly because it means workers are less productive because they are working with outmoded and unreliable equipment. It's also possible that low investment might itself be a sign that firms are anticipating lower future growth.

Thirdly, there's a problem of high global savings. For much of the 00s there was a savings glut as Asian economies and oil exporters ran big current account surpluses. Although these surpluses have declined, a new one has recently increased: Germans are saving more and more.

Markets are betting that these forces will continue for years. This does not mean that investors should respond to the prospect of low real yields by buying equities. The same low growth that is expected to keep bond yields low is also bad for dividend growth and share prices. Low real bond yields betoken low expected returns on assets generally.

Which poses the question: what might change to raise real yields?

One hope lies in research by James Hamilton at the University of San Diego. He and his colleagues point out that the link between trend economic growth and real yields is actually weaker than economists believe. Many other things, they say, affect yields. One, for example, is what Ricardo Caballero at MIT calls the safe asset shortage; only a few governments or companies can supply the top-quality assets which investors crave.

This suggests that one hope for higher yields would be a fall in demand for quality assets - that is, an increase in appetite for risk. Anything that increases this would raise yields. One candidate here would be signs of an upturn in the Chinese economy. Even better would be an improvement in corporate animal spirits which would generate increased capital spending. Although this is a forlorn hope in the UK, where Brexit-induced uncertainty will hit investment, it is a possibility in the rest of the world as the scarring effect of the financial crisis fades away.

These, though, are only hopes. Forecasts for real interest rates, says Professor Hamilton, "come with large confidence intervals." The implication of this might seem trivial, but it is nevertheless wise: investors should hold a diversified portfolio of cash, bonds and equities in anticipation of surprises.