Demographics and the bond market conundrum

September 3, 2014

Sept 3 (Reuters) – As we get older we become curiously
susceptible to arguments that it is not us who have changed, but
the world.

So it may be with the so-called bond market conundrum, in
which the effect of our aging demographics gets very little
attention despite likely having considerable impact.

As it was in 2005 when a puzzled Alan Greenspan made the
idea of the conundrum popular, the issue today is a divergence
between longer-dated Treasuries, which are falling in yield, and
monetary policy, which is tightening. If the Federal Reserve had
control over the bond market – itself a questionable idea – this
should not be happening.

But it is. Despite a steady tapering of bond purchases by
the Fed and growing expectations of an actual rise in rates next
year, 10-year Treasury yields have tumbled by more than a half a
percentage point so far this year, holding on Wednesday at just
2.41 percent. Even more strikingly, five-year yields have not
followed suit, a divergence the likes of which, according to the
Financial Times, we’ve not seen since the 1960s.

A host of explanations has been offered, from the idea that
bonds are tracking expected European Central Bank loosening, to
the possibility that this reflects better confidence that the
United States will be able to keep its budget under control.

Also possible, of course, is that bond yields are falling
because we really are facing a secular stagnation, an extended
period of low growth and stubbornly low inflation.

A look at our grizzled faces in the mirror might possibly
help to clarify things.

“Demography can account for the dramatic decline in both
inflation and bond yields in the U.S.,” writes economist Ed
Yardini of Yardini Research.

“Indeed, there has been a very close fit among the Age Wave
(i.e., the percentage of the labor force that is 16-34 years
old), the inflation trend, and the 10-year U.S. Treasury yield.”

As people age, much changes. In earlier stages of life
people tend both to accumulate assets, saving for their eventual
use during retirement, and do lots of stimulative spending, as
they outfit a house, raise and educate a family and generally
consume more in myriad ways.


All of this reverses as people age, which tends to dampen
economic growth, and also may drive the demand for bonds.

The United States now has fewer people in the 16-34-year-old
demographic than it has in more than 50 years, with just a bit
less than 36 percent in this cohort. That compares with more
than 50 percent in the mid-1970s.

While none of this perfectly explains what’s been happening
in the bond market this year, what an aging population does do
is drive a bid for bonds. Some of the difference in 5- and 10-
year bond yield moves this year may even be attributable to
demographic-driven liability hedging, for which longer-dated
bonds are used.

In any event, one clear impact of an aging population is
that older people and those who manage money on their behalf
will want more bonds, both to reduce risk as they near
retirement and, increasingly, as part of attempts to hedge
against living too long.

This is true of both individual savers and institutions.
Mutual fund data from 2010 shows that 401(k) account holders in
their 60s were nearly three times more likely to hold less than
40 percent in equities as were those in their 20s.

All of this is consistent with, at least, two interlocking
ideas: that demographics are contributing to low growth, low
inflation and low bond yields; and that demographics are driving
demand for bonds, which is making yields lower than they
otherwise would be.

To be sure, people age at a reliable rate of one day per
day, so demographic changes will be slower to be felt than what
we’ve observed in the markets.

Still, as the marginal buyer sets the price in a market, it
may be that more investors are buying into the secular
stagnation argument, perhaps buttressed by demographic trends.

A momentum trade, if you like, based on the idea that the
economy won’t have much momentum.

One other cautionary note – it is hard to reconcile this
fully with the very strong performance of equities. The test
will be how bonds and stocks react in the next year, as rates
either rise or as we all realize the reasons that won’t soon be
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by Dan Grebler)

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