The Bond Market’s Very Misleading Message
Much of the drop in yields on U.S. government securities has nothing to do with inflation, and even the bit that does doesn’t say anything interesting about where it’s headed.
Is money about to get cheaper?
Photographer: Alex Wong/Getty Images
When it comes to financial markets, narratives are powerful things -- and often misleading. The big (and unexpected) decline in yields on longer-term U.S. Treasury securities from about 1.75% in late March to a recent 1.15% has convinced many investors that central bankers were right all along, and that the faster inflation the world is currently experiencing is merely temporary and will decelerate again when supply-chain bottlenecks caused by the pandemic have eased. The trouble is that much of the drop in yields has nothing to do with inflation and even the bit that does probably doesn’t say anything interesting about where inflation is headed.
There are a number of ways to think about this. The first is that movements in bond yields don’t only reflect inflation expectations. In simple terms, the two main components of a Treasury bond’s yield are the real yield (which is what you get after accounting for inflation) and the expected rate of inflation over the life of the bond. (There is, or should be, a risk premium for both expectations being wrong, but put this aside for now.) The drop in 10-year yields the past few months reflects a decline in real yields, which you can easily see from the yield on 10-year Treasury Inflation-Protected Securities, or TIPS. In mid-March, the yield on 10-year TIPS rose to a “high” of minus 0.58%, before dropping to minus 1.20%. Measures of inflation expectations, though, rose over the same period.