Higher Rates Hide a World of Easy Money

The direction and pace of travel for yields probably matters just as much as the level

Ten-year government bond yields adjusted for headline consumer-price inflation

Source: FactSet
Note: monthly data

America first. The 10-year U.S. Treasury yield has returned to 3% for the first time since early 2014 and markets are clearly sensitive to higher rates. But the bigger picture is that investors are still living in a world with very low rates.

That can be seen in several ways. The first is obvious: yields in other advanced economies are still nowhere near where they were in 2014, with central banks like the European Central Bank way behind the Federal Reserve in tightening policy. Germany’s 10-year yield is 0.64%, down from close to 2% at the start of 2014; Japanese yields are stuck close to zero thanks to the central bank’s yield-curve control.

Change in 10-year government bond yield, year-to-date

Source: FactSet
Note: Japan's yield is unchanged this year

The more important way to look at yields is through adjusting for inflation. On that front, the U.S. is again out in front: the 10-year real yield, based on prices for Treasury inflation-protected securities, is around 0.8%. It has risen this year by about 0.3 of a percentage point, but by historical standards is still low. Real yields in Germany, the U.K. and Japan are negative. Indeed, in Europe and Japan, there are still swaths of bonds with negative nominal yields. That means financial conditions are still loose, providing support for the economy.
ECB President Mario Draghi and Fed Chairman Jerome Powell at the spring meetings of the IMF and World Bank in Washington, D.C. on Friday. Photo: Andrew Harrer/Bloomberg News 

Yet another way to look at it is via the rule of thumb that says longer-term bond yields should roughly equal the rate of nominal growth in the economy. But that rule has broken down in recent years. Last year, nominal growth in both the U.S. and Germany was 4.1%, according to FactSet; bond yields are well below that level. Central-bank policy, regulatory pressures and demographics are all factors in keeping bond yields low.

The problem for markets is that the direction and pace of travel for yields probably matters just as much as the level. That suggests higher yields are still likely to cause jitters for investors.

And markets just have to live with it: given how low yields are, the process of repricing global rates has some way to go

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