There has been a lot of talk in recent months about rising long-term bond rates. Since August 1, 2020, the yield on 10-year US Treasuries – the benchmark government bond that gets the most attention – has risen 124% and has increased 65% since early 2021, according to S&P Capital IQ. Over the same period, US 30-year Treasury bond yields rose 54% and 40%, respectively. Canada’s benchmark 10-year bond yields are even higher, up 223% between August 2020 and March 4, 2021 and 108% since January 1. The returns are now 1.54%, 2.3% and 1.4%, respectively.
This is all happening at the same time that the Federal Reserve and Bank of Canada say they won’t raise overnight rates – the short-term lending rate that gets the most media attention – until 2023. Both countries currently have overnight rates around 0.25%, the lowest they have ever been except during the 2008 recession. It may seem strange if overnight rates are held while longer-term yields rise, but the divergence is a sign that better economic times may be on the way.
Better future ahead
Long-term bond yields have long been fairly accurate, if not perfectly, predicting the direction of economic growth. The 10-year Treasury Department began to decline in June 2007, long before most people spoke of a major recession, and it began to fall again in 2019, long before the word “pandemic” became part of our daily lexicon. Interest rates saw a massive decline in mid-February 2020, a few weeks before the stock market crash.
While these may be just two examples in a long history of economic ups and downs, one is 2006 paper The New York Federal Reserve said: “Since the 1980s, there has been a large body of literature supporting the yield curve as a reliable predictor of recessions and future economic activity in general. Indeed, studies have linked the slope of the yield curve to later changes in GDP, consumption, industrial production and investment. “
So if the direction of return is looking to the future, then there is good news for those who are still struggling to imagine themselves at dinner parties and beach vacations as they read this: The recent surge in long-term interest rates shows that investors are are optimistic that life will return to some sort of normal in the next few years. (When that normalcy will occur is still unclear, however – 2-year bond yields, which are more like real-time indicators of economic growth, haven’t changed much in the last six months, meaning it’s not time to celebrate yet. )
Watch out for inflation
While rising bond yields can be a sign that vaccines and other treatments are working, they can also be a warning sign that more problematic issues lie ahead. Long-term fixed income returns usually rise with inflation, which means an increase in the price of goods or services. If people believe that inflation is going to rise too fast, then bond yields will rise too, since investors typically want the payments they receive on their bonds to cover the cost of living.
Economists generally want inflation to rise slightly – the Federal Reserve is aiming for a long-term average of 2% – but if it rises too quickly, the economy could collapse again. Trevor Galon, chief investment officer at Matco Financial in Calgary, told me, If everyone believes prices are going to rise dramatically over the next few months, spend as much money as you can today, rather than gradually over time. When inflation rises, the items people need to buy – groceries, for example – become too expensive to buy.
People are concerned about inflation. There is concern that prices could rise faster than economists would like if we start investing again and if the labor market recovers. There’s also the idea that too much government spending (and there was a lot) could ultimately lead to higher inflation because, according to the St. Louis Fed, “An increase in government purchases could drive up production costs. This in turn would boost inflation. ”