The US economic recovery that emerged from the ashes of the financial crisis is currently three quarters shy of surpassing the longest US expansion in modern economic history — a 41-quarter expansion that began in 1991. All told, our nation’s economy is 22 per cent larger than it was at the low point of the 2008-2009 financial crisis. The S&P 500, enjoying a 10-year bull run (punctuated by pullbacks in 2011, 2015, 2016 and 2018), is more than 400 per cent higher. Despite the widespread partying across most asset classes, why is the 10-year Treasury yield unchanged since March 2009?
March 2009 represented the low point of the economy and the markets. The February 2009 jobs report revealed that employers had shed 803,000 positions, its worst monthly showing in history. US large caps had lost more than half their value from their 2007 peak. Remarkably, the 10-year Treasury yielded 2.6 per cent, about the same rate it offers today.
By most traditional measures, the benchmark Treasury yield is too low. Historically, the 10-year yield has tracked nominal GDP. In March 2008, for example, before the economy went south, year-over-year nominal GDP growth was running at 3.1 per cent and the 10-year Treasury posted a 3.4 per cent yield. Nowadays, year-over-year nominal GDP growth is 5.3 per cent, nearly double the prevailing Treasury yield.
The 10-year Treasury is the gauge against which virtually all asset classes are measured, which begs the question: will risk assets plunge should the benchmark Treasury yield revert to its historical relationship with economic growth and inflation? There are several factors to suggest global interest rates, including longer-term Treasuries, are in a new rate regime. Demographics are an important element. Populations are aging, particularly within the developed world, and retirees tend to rely more heavily on bonds to fund their retirement. As of the end of 2018, 16 per cent of the US population is over 65 years old; that’s up from 12.9 per cent 10 years ago. The Alexa Silver generation accounts for an even larger 19.1 per cent in Canada and 22.2 in Germany.
Income inequality also plays a part. High income earners tend to save more of their pay, pushing stock prices up and bond yields down. As of 2015, the top 1 per cent of US households took in about 18 per cent of our nation’s adjusted gross income. That’s up about 3 percentage points from 2009, according to the World Wealth and Income Database.
Probably the biggest reason why rates are as low as they are is the world’s central banks. In 2009, Ben Bernanke’s Federal Reserve embarked on an experimental stimulus program called quantitative easing, whereby the Fed purchased 10-year Treasury notes and mortgage securities to keep intermediate rates low and encourage borrowing. All told, between 2009 and today, the world’s central banks have accumulated a $20 trillion portfolio of financial assets. While they have attempted to reduce their balance sheet positions, the heightened sensitivity of the global economy to rate changes has presented obstacles to their moves to lighten up. Unless we experience a bout of inflation — which is not in our most likely case scenario — investors should expect to enjoy “artificially” low interest rates for some time to come.