From Treasuries to German bunds, and corporate bonds to mortgage securities, the world's fixed-income market is poised for its best year since 2002 as slow growth, tame inflation and record low interest rates create an almost perfect environment for debt investors.
Bonds have returned 6.57% in 2010, including price appreciation and reinvested interest, a pace that would total 7.94% for the year, based on Bank of America Merrill Lynch's Global Broad Market Index. That would be the most since the measure, which tracks more than 19,000 securities with a par value of $36.9 trillion, surged 8.92% in 2002.
Money is pouring into debt as central bankers refrain from raising rates as inflation slows. That's allowing the U.S., U.K., Germany and Japan to fund record budget deficits, private-equity firms to refinance debt loads used in buyouts and mortgage rates to fall to new lows.
"We are in a Goldilocks environment for fixed income that will last for the next five to 10 years," predicted Scott Minerd, who helps oversee more than $100 billion in New York as Guggenheim Partners LLC's chief investment officer. "Rates will stay low until inflation comes back and unemployment turns around."
Fixed-income mutual funds have attracted $555.4 billion in the two years that ended Sept. 30, more than the $496.9 billion that went to equity funds during the height of the Internet boom in 1999 to 2000, according to data compiled by Bloomberg News and the Investment Company Institute in Washington.
About $38.4 billion has flowed out of stock funds this year.
Bond yields average 2.18%, below the average of 3.81% the past 10 years, as measured by the B of A Merrill Lynch index.
For a government or a company, that means annual interest savings of $16.3 million on every $1 billion borrowed.
Some of the biggest bond firms say the best may be behind as the Federal Reserve prepares to print more money and flood the world with dollars in an effort to avoid deflation.
Bill Gross, who oversees about $1.24 trillion as co-chief investment officer of Pacific Investment Management Co. in Newport Beach, Calif., said last week that the 30-year bull market is almost over because "certain maturities can't go much lower in yield."
He compared the government bond market to a Ponzi scheme, dependent on finding more investors so borrowers can roll over an ever-rising amount of debt.
So far, that hasn't been a problem for U.S. President Obama, U.K. Prime Minister Cameron, German Chancellor Merkel or Japan Prime Minister Kan.
Investors have placed $5.7 trillion in bids for the $1.9 trillion of notes and bonds sold by the U.S. government this year, according to data compiled by Bloomberg.
The almost 3-1 ratio is a record, even though the U.S. budget deficit exceeded $1 trillion for a second year.
In Japan, the sale of 30-year securities by the government on Oct. 14 drew bids for 5.4 times the amount offered, the most in eight years.
"The trend in yields is still downward," said Lacy Hunt, executive vice president at Hoisington Investment Management Co. in Austin, Texas, whose Wasatch-Hoisington U.S. Treasury Fund has returned 7.3% on average the past five years, beating 96% of its peers. "'Until the economy turns around, we won't see any inflationary pressure, which means fixed income can rally further."
The International Monetary Fund in Washington has forecast the world economy will expand 4.2% next year, compared with 4.8% in 2009. Though slowing, that's still better than the average of 3.69% from 2000 through 2008.
Companies are among the biggest beneficiaries of record low government yields and global growth, giving investors the confidence to finance even the riskiest borrowers.
Company bonds from the U.S. to Europe and Asia have returned 9.7% this year on average, according to B of A's Global Broad Market Corporate and High-Yield Index. Debt rated triple-C and lower has gained 17.7%.
"Investors are still looking for yield," said Rick Rieder, chief investment officer of fixed income at BlackRock Inc., the world's largest money manager, overseeing $3.45 trillion. "The need for yield in a shrinking fixed-income atmosphere and the activities of the Fed will pressure yields lower, but not with the same vigor as it has been so far this year."
Central bankers, such as the Fed, are taking steps to keep the recovery from the worst financial crisis since the Great Depression on track. Fed Chairman Ben S. Bernanke has kept its benchmark rate in a range of zero to 0.25% since December 2008, while the Bank of England's is at 0.5%, the European Central Bank has a target of 1% and Japan's is virtually zero.
The Fed is resuming its purchases of Treasuries to inject cash into the economy, announcing quantitative easing worth $500 billion on Wednesday.
The central bank bought $1.7 trillion of government debt and mortgage securities in the first round, between October 2009 and March 2010.
"History has proven the Fed can keep long-term interest rates low for an entire decade if it believes it is warranted in order to ensure the viability of long-term economic recovery," Minerd wrote in a note last week to clients.
He pointed to the 1940s, when 10-year Treasury yields averaged 1.99%, amid the Fed's first asset purchases that were designed to finance World War II and spark the economy.
"A lot of the quantitative easing is priced in and real rates are not very generous, but in the current atmosphere this is not a good argument against investing in fixed income," said Christine Todd, a managing director and head of the group that oversees $26 billion in tax-sensitive fixed-income portfolios at Standish Mellon Asset Management Co. in Boston.
