Death Valley and Bond Yields - October 22, 2018

Death Valley is in California. Besides its reputation for summertime temperatures of 120 degrees, it’s also known as the lowest spot in the USA – 282 feet below sea level. Following the recession in 2008-09, the yield on the 10-year Treasury took a trip to Death Valley, falling to just 1.37% in July 2016 (St. Louis Federal Reserve). Put another way, you could lend Uncle Sam cash for 10 years and earn 1.37% per year.

As Figure 1 illustrates, the yield was the lowest in over 100 years. In fact, July’s bottom is the lowest in the history of the Republic, according to BofA Merrill Lynch. Notably, the spike in yields in the 1970s was an anomaly when viewed from a long-term perceptive.

10 22 18 treasury yield

But we’ve been experiencing a shift in the winds. The Federal Reserve has raised the fed funds rate, a key short-term rate, eight times since December 2015, and U.S. economic activity has accelerated, pushing the yield on the 10-year bond to its highest since May 2011 (St. Louis Fed).

We’d expect rates to rise as a growing economy is likely to increase the demand for money, making it more expense via higher rates. Still, the uptick in yields has been fairly gradual. But, are yields still too low?

It’s impossible to provide a definitive answer. Forecasting the direction and level of bond yields is much like guessing the outcome and score of a football game. There are too many unknown variables during the game that can affect the outcome.

But one graphic suggests yields may be low, given the recent pickup in growth. Figure 2 highlights that Treasury yields have loosely tracked nominal GDP, which is real GDP (actual change in economic activity), + inflation. But be careful!

10 22 18 nominal gdp

This model doesn’t project the timing or magnitude in the change of yields, if any. It simply shows there is a loose relationship between nominal GDP and the yield on the benchmark 10-year bond.

10 22 18 index

Sources: U.S. Treasury, MarketWatch, St. Louis Federal Reserve, CNBC

Yields have hovered near low levels thanks to low inflation, low rates from global central banks, and the general uncertainty we’ve experienced during much of the economic expansion.

Apart from recent years, the current yield hasn’t been this low since the late 1950s. And a sudden economic slowdown in the U.S. and/or renewed global uncertainty could push yields lower.

But, faster economic growth and a Fed that has been willing to gradually hike interest rates have helped lift bond yields out of the basement, or in this case, off the valley floor of Death Valley.