INVESTING
a day or two around its announcement , but over time macro factors matter more because the markets are segmented . The evidence is even shaky that quantitative easing matters for long-term bonds ( though the size and scope of more recent QE may be a different story ).
Long-term rates are determined by factors such as supply and demand for bonds , which are a function of how much the economy values future consumption . And high debt levels , which are getting higher over time , mean more supply and possibly less demand from abroad — pointing to still higher rates .
The other big factor is the term premium , or how much the market rewards speculators for taking on more duration and inflation risk . If expected inflation is higher , rates will be higher too . Low and stable inflation is probably a big reason that rates trended down in
Long-term rates are determined by factors such as supply and demand for bonds , which are a function of how much the economy values future consumption .
Yes , Investors , There Is Such A Thing As Rising Interest Rates
After declining for the better part of 40 years , interest rates have begun to climb in the last year and a half .
20 %
10 %
0 %
-10 %
10-year real interest rate
Source : U . S . Federal Reserve
10-year nominal interest rate
1982 1990 2000 2010 2020
The Break-Even Inflation Rate Is Still Relatively Low
The question is how long it will stay that way .
3 %
2 %
1 %
10-year break-even inflation rate
0 % 2003 2010 2015 2020 2023
Source : U . S . Federal Reserve the last few decades . Bond bulls point out that rate expectations , surveys and breakevens are still stable and relatively low .
But the term premium does not just reflect inflation expectations . It also includes an inflation risk premium — that is , risks around future inflation . It ’ s important to look at the range of expectations and how confident people are in their forecasts to get a sense of risk . Inflation uncertainty is still elevated , and it barely budged in the last year , suggesting a higher risk premium going forward . The uncertainty may dissipate if inflation falls to 2 % and stays low for another several years . But if inflation spikes again , the inflation risk will be a factor in a way it has not been for decades .
Myth 3 : An aging population means future bond yields will be lower . There has long been a narrative that bonds yields fall as the population ages , because older people buy more bonds and take fewer risks . Just look at Japan . But recent work shows this relationship is not so clear , especially considering the long history of 10-year bonds across countries . Moreover , most developed countries have both large underfunded entitlements and aging populations , which suggests they will have to issue much more debt . Since older U . S . households do not buy debt at the rate the Japanese do , odds are that the effect of an aging population will be an increase in rates , not a decrease .
No one knows , of course , what will happen in the bond market — including me . Perhaps the decade after the financial crisis was the new normal , and the economy will revert to it . What ’ s more likely , however — based on centuries of data and the long-forgotten truth about bonds — is that the world is facing a period marked by more volatility and higher interest rates . That means bonds will be interesting again , and maybe not so safe .
ALLISON SCHRAGER is a Bloomberg Opinion columnist covering economics . A senior fellow at the Manhattan Institute , she is author of An Economist Walks Into a Brothel : And Other Unexpected Places to Understand Risk .
40 | FINANCIAL ADVISOR MAGAZINE | NOVEMBER 2023 WWW . FA-MAG . COM