12 October 2023
Last month, US bond yields reached the highest level in 15 years. The surge in nominal bond yields has coincided with an increase in real yields, the yield paid above inflation on Treasury inflation-protected securities (TIPS).
Over the decade from 2013 to 2022, this yield averaged just 0.14%. It has been a long time since investors could guarantee a meaningful real return by buying US government bonds. With that real yield now above 2%, are global developed market bonds offering value, or could the real yield go higher, and what would the implication be for other asset classes?
Unfortunately, US TIPS only started trading in 1997, so there is only an observable history of real yields in the US for the past 25 years. Over this time, the 10-year real yield averaged 1.45%. But 25 years is a relatively short time window in global macro, especially given that the last 25 years encompassed the post-GFC period of quantitative easing, which arguably distorted real yields. To try and get a longer history to compare current real yields to, we look at both the historic yields on UK inflation-linked gilts as well as the difference between US 10-year nominal yields and 10-year inflation expectations at the time.
Using data from the Philadelphia Fed’s Survey of Professional Forecasters and, before that, the Livingstone and Blue-Chip surveys, we were able to get 10-year inflation forecasts back until 1979. Combining these forecasts with actual nominal bond yields at the time could give a proxy for what real yields would have been at that time.
We plot these series below. Firstly, we can see that our proxy series of nominal yields less inflation expectations seem to estimate real yields reasonably well. Secondly, with a longer data series, we see that real yields have historically been at higher levels than we have seen over the past decade.
Source: Philadelphia Fed, Bank of England, Mergence Calculations
We combine these data series to get a ‘best estimate’ of US 10-year real yields, using actual TIPS yields when available and our alternative proxies prior to that.
Source: Philadelphia Fed, Bank of England, Mergence Calculations
Using this series, we calculate the average 10-year real yield over the past one to four decades. The further back we look, the higher the average real yield.
What conclusions to draw from this? Firstly, this highlights just how abnormal the asset pricing environment was over the period from 2010 to 2020. Also, using more historic data adds some support the bear case for treasuries. On the other hand, real yields are already higher than their average over the past 10, 20 and 30 years. But it is also important to ask what drove these higher real yields in the past? If inflation volatility and uncertainty remain high, could we see a return to 4% plus real yields?
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