Ed Peters
January 19, 2022

Real intermediate- to long-term US bond yields have been negative since March 2020. While low real yields can be partially attributed to the Fed’s bond buying program, there is likely something else at work here.

Bond yields are typically higher than inflation, but there have been times when this has not been true – in particular, during periods of high inflation when supply shortages are the issue. As we showed in a recent paper, during the shortages of the post-World War II era (1946-1948), inflation hit 20%, yet bond yields remained in the 2% range, resulting in a real yield of about -18%. During the OPEC oil embargo of 1973, inflation hit 12.2%, but real yields remained at a decidedly negative -5% throughout the crisis. Real yields did not turn positive until 1975, almost 2 years after the embargo itself. In both cases, it appears that the bond market believed the high inflation of those eras to be “transitory,” even though it lasted for two to three years.

It is possible that the bond market is once again, in its collective wisdom, telling us that the current bout of inflation will also be temporary. After all, inflation has been high for less than a year, and by 1947 and 1973 standards, is still modest. Of course, now we have better measures of long-term inflation expectations. If higher expectations become embedded, economic theory tells us that is a self-fulfilling prophesy. I can tell you from experience that when inflation reached 14.6% in March 1980, the general feeling was that high inflation was going to be a way of life. I was taking an economics course at the time, and I remember the professor saying that we could live with 10% inflation indefinitely. And that’s what we expected back then, along with a standard 10% cost-of-living raise. Real yields accordingly turned positive in late 1980, reflecting a widespread belief that inflation had become anchored at high levels.

The bond market of today is saying we’re not there yet. The Fed is likely moving to keep it that way. Even so, we should not expect real bond yields to necessarily become positive. In fact, that is not likely, based on history. But it’s something to watch carefully.

Past performance is no guarantee of future results. Potential for profit is accompanied by possibility of loss.
© First Quadrant, LLC, 2022. Intended for Institutional and Qualified Eligible Persons Use Only. The views expressed are the views of First Quadrant, LLC, only as of the date shown and are subject to change without notice based on market and other conditions. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice, recommendation, or solicitation of any particular security, strategy or investment product. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. It is your responsibility to be aware of and observe the applicable laws and regulations of your country of domicile. All material has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.

Related Posts