BONDS YIELDS´ BROKEN LINK WITH GROWTH / THE WALL STREET JOURNAL

Heard on the Street

Bond Yields’ Broken Link with Growth

Yields have defied predictions to rise; the 10-year German Bund still at odds with the economic Outlook

By Richard Barley

May 28, 2015 11:31 a.m. ET


A U.S. flag flies on top of the Federal Reserve building in Washington, D.C. Photo: Bloomberg
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April’s bond market squall has subsided. Ten-year yields in the U.S., Germany and the U.K. are around 0.5 percentage point above their lows for the year. But by historical standards, including relative to other economic and financial indicators, they remain extraordinarily low.

One rule of thumb for yields that has a decent historical track record is that they track nominal growth in gross domestic product. In the U.S., for instance, 10-year Treasury yields lagged behind nominal gross domestic product as inflation built in the 1970s, but then tracked lower as the U.S. Federal Reserve moved to rein in prices. Between 1980 and 2003, the two rates moved together relatively closely.

Since then, the picture has become more confused. 10-year Treasury yields rose between 2003 and 2007, but not by as much as the pickup in nominal growth might have suggested; that was at the heart of former Fed Chairman Alan Greenspan’s bond conundrum. And since the start of 2010, U.S. nominal GDP growth has averaged 3.9%, while Treasury yields have averaged 2.5% based on quarterly data. Yields have persistently defied predictions that they would rise.

                                       

In the eurozone, the economy has taken a bigger hit, but even so, 10-year German Bund yields had departed from reality in April when they reached 0.05%; at 0.5% now they still are at odds with a brighter economic outlook for Europe. Yields are still negative for German bonds out to January 2020.

Clearly, central bank policy since the global financial crisis, and in particular massive waves of quantitative easing, has pushed bond yields to levels lower than they otherwise would have been. But that seems unlikely to explain the disconnect fully. Bond yields appear to be painting a picture of permanently depressed growth and inflation; that seems hard to justify in the longer term.

One suggestion is that the risk of new financial or economic trouble is hanging over investors and depressing bond yields. That might be being reinforced by the continuation of ultra-loose central bank policy, since some policy makers stress heightened uncertainty as a reason for keeping rates low.

A move toward tighter monetary policy is the most likely catalyst for a further rise in long-dated bond yields. April already proved painful for bond investors. If the link between nominal growth and yields reasserts itself, there is plenty more pain to come.