A combination of factors are contributing, including:
1. Low growth
The simplest explanation is that low rates are a function of slow growth and low inflation, or more succinctly low nominal GDP (or NGDP). Over the past half-century the level of NGDP has explained roughly 30% of the variation in long-term rates, according to Bloomberg data. If you look at the chart below, NGDP is currently close to 3%, a historical low, suggesting rates should also be low. However, based on current levels one would expect the yield on a 10-year Treasury bond to be around 4.25%. That would still actually be low by historical standards; clearly something other than low growth is impacting rates.
Market Realist – Nominal GDP growth has affected yields.
The graph above compares year-over-year nominal GDP with ten-year U.S. Treasury bond (IEF) (TLH) yields over the last five decades. As you can see, yields tend to move in tandem with nominal GDP. Lower inflation rates lead to lower yields, which partly explains the relationship.
A slower real GDP growth rate causes lower yields since investors are less bullish about equities (IVV) (IWM) and buy more bonds (AGG) in order to preserve capital. Remember, bond prices and yields are inversely correlated. Slower nominal GDP growth over the years has caused yields to decline.
However, the US GDP growth rate is on a somewhat solid footing compared to the rest of the world (ACWI). The stronger dollar (UUP) has been a drag on exports and, by extension, on GDP growth.
However, there are several other factors that have also caused yields to plummet. We’ll look at these in the next few parts of the series.