Morgane Delledonne
Associate Director –Fixed Income Strategist
[email protected]
7 February 2017
ETF Securities Fixed Income Research:
What is behind the rise of global bond yields?
Summary

The rise of US yields is driving up yields around the world.
What is driving US yields higher?

We expect higher volatility in global rates, amplified by
geopolitical risks and commodity price movements.

Structural headwinds and accommodative foreign
monetary policies will likely limit the rise US yields over
the medium term.
Long-term bonds yields are a function of the expected future
short-term interest rates and the bond term premium that
investors require to buy long-term bonds rather than roll over a
series of shorter maturity bonds (i.e. inflation risk premium).
The trend decline in global yields in the past 35 years mostly
reflects the trend decline in bond term premium, while
expected short-term interest rates fluctuate along with the
changes in monetary policies.
Since last November, investors’ sentiment has turned into
‘risk-on’ mode, favouring risky assets and equities relative to
bonds. The rise in global yields and the steepening of yield
curves has fuelled fears about the end of the 35-year bond bull
market.
Decomposition of 10yr Treasury yields
18
%
10yr Expected short-term rate 10yr Treasury Term Premium
16
US yields drive up global yields
14
12
Since the early 2000s, the rise of global financial integration
(i.e. the increase movements of capital between economies) has
been reflected in higher co-movement in global yields. The
chart below shows that almost 60% of the changes in bond
yields of advanced economies (US, UK, Germany, and Japan)
may be explained by a common factor.
70%
60% of US yields may be explained by moves in
other major bond yields
R-squared
US 10yr Treasury yields
10
8
6
4
2
0
-2
1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014
Source: Adrian, Crump, Moench (2011), FRBNY , Bloomberg, ETF Securities as of close 02 February 2017
(Coefficient of determination)
60%
50%
40%
30%
20%
10%
0%
1995 1997 1998 2000 2002 2003 2005 2006 2008 2009 2011 2013 2014 2016
Source: Bloomberg, ETF Securities as of close 01 February 2017
Notes: The chart shows a 5y r rolling regression of monthly changes in US 1 0y r y ields that captures the
monthly changes in Japan, German and UK 1 0y r y ields.
The recent rise of global yields was predominantly driven by
the rise of US yields along with cyclical factors (such as
inflation, geopolitical risk and market volatility). However, we
believe the ongoing accommodative monetary policies in
Europe and Japan are likely to keep bond yields low in these
regions, limiting the rise of US yields over the medium term.
Expected short-term rates started to increase in December
2013 when the Fed announced the tapering of its monthly bond
purchases. However, US bond term premiums continued to
decline and then slipped into negative territory in the first half
of 2016 – for the first time in history. Deflation fears fuelled by
the 70% drop of energy prices between 2014 and 2015
negatively affected inflation risk premiums, which declined
from 0.5% to -0.5%. The sustained rebound in energy prices
since February 2016 enabled inflation premiums to bounce
back in Q4 2016, leaving both forces – bond term premium and
expected short-term rates - trending upward. As a result, US
long-term yields started to rise.
We evaluate the current mispricing of the 10yr treasury yield at
10bps tighter than its estimated value, based on the gap
between the current 10yr yields and the sum of its two
components. Thus, we believe most of the expected three rate
hikes from the Fed this year have already been priced into 10yr
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ETF Securities Research 2016
yields. However, we expect higher rates volatility amplified by
elevated volatility in energy prices and geopolitical risks. The
MOVE index (an indicator of bond markets volatility) has
increased 20% since Q4 2016.
Structural headwinds push yields
down
The recent tightening in US financial conditions has been
driven by the prospect of a better economic outlook in the US,
reflecting current expectations of larger fiscal policy stimulus.
In our opinion, the efficiency of the fiscal stimulus and its
effects on bond markets will crucially depend on its fiscal
neutrality and on its capacity to boost productivity and labour
force growth. While the labour force growth has rebounded
since 2012 under the accommodative monetary policy of the
Fed, US productivity growth remain low from an historical
perspective and continue to weigh on the economy.
4
Productivity and labour force influence the long
run trend in potential output
US Productivity growth (%yoy)
3.5
The decline trend of investment in advanced economies can be
partly explained by high credit constraints. The Debt Service
Ratio (DSR) or the share of income used to service debt has not
yet return to the pre-crisis levels, weighing on consumption
and investment.
Subdued long-term economic trend
limit yields’ rise
The gradual decline in the US GDP growth trend has led to
gradual similar decline in the neutral real interest rate (i.e. the
federal funds rate that neither stimulates nor restrains
economic growth), which, in turn, has caused the decline in
long-term interest rates. The US Congressional Budget Office
(CBO) forecasts a stable 2% potential real GDP growth – the
highest level of real GDP that can be sustained over the long
term – for the US economy over the next 10 years. Accordingly,
the neutral real interest rate for the US is expected to pick up
and move in tandem with the potential real GDP. Although,
both remain lower from a historical perspective.
Neutral Real Rate and US Potential Real GDP
Growth
6
US Labour force growth (%yoy)
3
5
2.5
4
2
FOMC
long-run
projections
of Real GDP
growth (%)
3
1.5
2
1
1
US Potential Real GDP Growth (%)
Laubach-Williams Neutral Real Rate (%)
0.5
0
1983
0
1986
1989
1992
1995
1998
2001 2004 2007 2010
2013
2016
Source: Bloomberg, ETF Securities as of close 06 February 2017
Historical data reveals a strong positive relationship between
investment and labour productivity.
25
Debt level in advanced economies push
investment and real yields lower
0
Investment (%GDP, rhs, reversed axis)
23
Debt Service Ratio (%)
5
21
10
19
15
17
20
15
1999 2001 2002 2003 2005 2006 2007 2009 2010 2011 2013 2014 2015
25
-1
1967
1972
1977
1982 1987
1992 1997 2002 2007 2012 2017 2022
Source: CBO, FOMC, ETF Securities as of close 03 February 2017
This analysis is consistent with the gradual downward revision
of long-run projections from the FOMC. From 2012 to today,
the FOMC gradually revised downward its estimates for the
long-run potential GDP growth rate and the terminal fed funds
rate (or neutral interest rate) from 2.4% to 1.8% and from
4.25% to 3.00% respectively. Fed Chair Yellen reiterated in
January1 that the Fed expects to increase Federal Funds rate
target a few times a year until, by end of 2019, it is close to its
longer-run neutral rate of 3%. Accordingly, we expect the Fed
to hike rates three times this year.
We expect the trend rise of the US yields to be gradual over the
medium term toward 2019 amid higher volatility. The upside
risks to this view would come from a significant and quickerthan-expected rebound in productivity growth and inflation.
Source: Bank of International Settlements, Bloomberg, ETF Securities as of close 01 February 2017
1
In a speech “The Goals of Monetary Policy and How We Pursue
Them”.
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ETF Securities Research 2016
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