Low Bond Yields Have Little to Do With Lax Monetary Policies

Demographic trends are having a very significant impact on savings and risk appetite.

High savings rates lower bond yields.


The general perception is that global bond yields are historically low because monetary policy has been aggressively eased. This leads to expectations that yields will rise -- possibly sharply -- once the Federal Reserve and the European Central Bank start the process they call “balance sheet normalization.” After all, when he was Fed chairman, Ben S. Bernanke spent a lot of time and effort trying to push bond yields lower. The same is true of the ECB’s Mario Draghi and the Bank of Japan’s Haruhiko Kuroda.

But there’s a strong case to be made that this perception is wrong. If lax monetary policy is not the reason, then why are yields so low? An examination of 10-year government bond yields based on quarterly data for 21 countries since 2000 shows that the phenomenon can be explained by three factors.

The first is inflation expectations, which follows directly from the so-called Fisher Equation stating that nominal interest rates are equal to real rates plus the expected rate of inflation. Since the beginning of this century, the coefficient on 10-year inflation expectations is nearly exactly one, confirming the validity of the Fisher Equation. This also means that the impact of monetary policy on bond yields primarily follows from its impact on inflation expectations. If anything, recent monetary policy has contributed to lowering bond yields because monetary conditions have been too tight to fuel inflation expectations -- flying in the face of the conventional market wisdom.

Secondly, there has been a significant re-regulation of global financial markets, particularly since Basel III was introduced in 2011. Among other things, its provisions require banks and other financial institutions to hold safer assets -- including highly rated government debt. Stricter regulation alone has been responsible for lowering yields anywhere from 100 basis points to 170 basis points across developed economies.

The results of this statistical analysis can be used to break down the changes in global bond yields over the past decade, from just before the outbreak of the Great Recession in 2008 to today. Altogether, 10-year bond yields in developed economies dropped in the range of 200 basis points to 300 basis points.

Finally, and perhaps most importantly, demographic trends are having a very significant impact on savings and risk appetite, and those affect bond yields. We can capture this relationship by tracking the share of a country’s total population that is between 65 and 74 years of age, allowing us to observe changes in savings behavior and risk appetite that occur when people retire and leave the labor market.

Policy makers and commentators seem to expect that, sooner or later, bond yields will climb back to the levels typical before 2008. That view, however, does not allow for the profound demographic changes we will see in the coming decades as populations continue to age. This phenomenon is truly global in scope, with its effects particularly evident in Asia and Central and Eastern Europe. They are also quite significant in North America and Western Europe.

When plugging the United Nations forecast for the changing share of those aged 65 to 74 into our regression model to forecast aging’s impact on bond yields, the results are striking. Across countries, we see that demographic changes could push down bond yields -- assuming unchanged inflation expectations and unchanged effects from financial regulation -- by 50 basis points to 100 basis points on average. The only two exceptions are Japan and Sweden, as the share of 65- to 74-year-olds in both countries is set to decline over the coming decade. That should help push up domestic bond yields.

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