It is no coincidence that for some time now, even in discussions about stocks, developments in bond markets have been widely discussed. Ten-year bond yields can be (in my opinion) the most important price on the financial markets. And even though they already corrected from the 5% levels, their overall growth this year was very noticeable. Sometimes I present here various considerations and theses about where they might settle, today I will add two more.
Bloomberg provided the following demonstration of what government bond yields could look like depending on the growth rate of nominal output and the amount of government debt. I have written here several times that from a historical point of view, the equation between nominal growth and ten-year bond yields can be used as a very rough measure. If, for example, the potential of the real product reached approx. 2% and we added 2% inflation, we have 4% nominal growth. And with that assumption, yields “should” be at 4%. What about Bloomberg?
The chart doesn’t stick to that – even in the low-leverage sector, yields exceed nominal product growth. At the same time, this pattern can be observed in the past in a period of higher inflation (the opposite then occurred in a period of noticeable disinflation, and as a result I am talking about an imaginary average, when returns are equal to nominal growth):
The graph is probably intended mainly to look at the relationship between the level of government indebtedness and bond yields. One of the most famous studies devoted to this topic years ago claimed that a certain critical limit is government debts above 100% of GDP. In the sense that after that they start to have a negative impact on economic activity. But there are a lot of theses and interconnected variables and causalities abound. I don’t know what the graph is based on exactly, but even according to it, approx. 100% is a certain turning point: At higher growth rates, yields begin to rise noticeably with further increasing indebtedness (this is not the case at lower levels of the growth rate).
The variables listed in the graph affect each other through a tangle of circular references, and the graph can only be an illustrative example of how this might work. At the same time, government debt now stands at 120% of GDP, bond yields are at 5%, and nominal output grew by about 6%. If we were to take the chart as a bullish coin, the current yields are still quite low from this point of view. But not so if we count on a relatively rapid decline in growth, especially on its inflationary side.
2. Two percentage points above inflation: Today’s second chart shows the difference between yields and inflation, its very long-term average is at 2%. With current yields of around 4.6%, this would imply a longer-term expected inflation of around 2.6%. So quite noticeably above the Fed’s target. The real 2% of bond yields then coincidentally correspond with estimates of the potential, which were around 2% before 2020 (that is, with the equality of growth=revenues).