The meaning of 3% Treasury-bond yields

ROUND numbers would be irrelevant if investors were rational. But they are not. This week the ten-year Treasury-bond yield passed the 3% threshold for the first time in over four years and investors shuddered. Their worry is that the long downward march in yields, which began in 1982, may at last be over. Is it?

That question is not of interest just to bondholders, for whom higher yields mean lower prices. Government-bond yields set the benchmark for the borrowing costs of companies and consumers. When they rise, the weakest companies and the most indebted consumers are likely to get into difficulty. If the cost of government borrowing rises, it becomes harder to finance budget deficits. Politicians may be forced into cutting spending or raising taxes. If the breaching of the 3% threshold were to presage an abrupt rise in yields, there could be trouble ahead (which is why stockmarkets wobbled this week). Yet a bond-market bloodbath seems unlikely.

It is no surprise that bond yields have been trending upwards. They reached historically low levels after the financial crisis of 2007-08, when central banks pulled out all the stops in an attempt to revive the global economy. Trillions of dollars of government bonds were bought as part of quantitative-easing (QE) programmes. As worries mounted about “secular stagnation”, an extended period of slow growth and low inflation, investors were even prepared to lock in losses. At one point more than $10trn-worth of bonds traded on negative yields.

Last year, however, the global economy seemed to pick up again. Central banks withdrew some monetary stimulus. At the same time, governments started to ease fiscal austerity. The developed world may have reached a turning-point, where the amount of QE steadily dwindles and the amount of government-bond issuance rises. America is leading the way. The Federal Reserve is paring back its bond holdings. And after the tax cuts passed in December, trillion-dollar deficits are forecast from 2020.

The main threat to the government-bond market has historically been higher inflation. Headline inflation rates have ticked up a bit and the recent surge in the oil price may add to the pressure (see article). Tighter labour markets could yet push up wages and have a more lasting impact. But at the moment, the only OECD countries with annual inflation rates of more than 3% are Mexico and Turkey.

A sharp rise in bond yields may be self-limiting. The IMF warned on April 18th that global debt is higher than ever, relative to GDP. The risk that higher borrowing costs could sharply slow growth ought to dissuade central banks from tightening monetary policy too quickly.

Jumpy investors should remember Japan. Government-bond yields there have defied two decades of forecasts that they will move higher. Betting against Japanese bonds proved to be such a bad trading strategy that it became known as “the widow-maker”. It is too early to proclaim the end of the low-yield era elsewhere, too. Economic data so far this year have been rather disappointing, particularly in Europe (see Finance section). And the gap between two-year and ten-year Treasury yields has narrowed since early February, from three-quarters of a percentage point to around half a point. This flattening of the yield curve is often seen as a sign that the market believes the peak in interest rates may be getting close.

The world is flatter

Some even think that the lows for government-bond yields are still to come. When the next recession hits, as it eventually will, central banks may not have the leeway to cut short-term rates by the four percentage points or so that are the typical response to a downturn. They may have to unleash a new round of QE and buy lots more bonds.

So do not panic. Even if bonds yield a bit more than 3%, that is a lot lower than the level which prevailed before 2007. Pension funds, insurance companies and retired savers will still be willing buyers of bonds at these rates. Unless inflation unexpectedly surges, this is not a rout.