Why Yields Are a Joke

At Roth Research, long-term Treasuries are on our blacklist.

How We Got to “High” Yields

Among the many unexpected financial developments resulting from the economic shock of the pandemic was one that many economists and analysts never expected: along with inflation, elevated Treasury yields. Since 2008, as the economy languished in a low-growth, nearly deflationary paradigm, low bond yields had been a fact of life. After nearing 4% in early 2010, the 10-year Treasury bond fell below 2% in 2012 and stayed under 3% until the pandemic, with the exception of a brief interval in 2018. (This was the infamously short Fed hiking cycle that was kiboshed after the hikes began to cause economic disruption.)

All the while, the United States actually had some of the highest yields in the developed world. Many other countries, but particularly Switzerland and Japan, actually cut rates to negative in one of the more bizarre chapters in economic history. Then came the pandemic, and further aggressive stimulus brought the 10-year bond near 0.5%. It seemed like it would remain low forever—but then came inflation, and interest rates had to be hiked to keep up with it. (Since they dissuade borrowing and hence economic activity, higher interest rates are the prime tool central bankers use to “cool down” the economy, i.e. lower inflation.)

Started at the bottom, now we’re here. The long-term rates that have fluctuated between 4% and 5% over the last several years are certainly a major improvement on the sinking feeling that comes with putting your hard-earned savings into investments that have a practically insignificant return. Many investors are satisfied with better than zero rates and don’t look beyond that. And we wish we were like them. But ignorance is bliss, and sadly, a year as a Wall Street analyst bred economic ignorance right out of us.

Yields are Actually a Joke

There are two kinds of interest rates (well, two kinds of anything, really, but let’s stick to interest rates for now). These are referred to as nominal rates and real rates. Nominal rates are the literal rate, with no adjustments. If a bond pays 3%, the nominal rate is always 3%. Real rates, however, subtract the inflation rate from the interest rate. If a bond pays 3% and inflation is 3%, the real rate is zero. The real rate is more honest because if you invest for a year, get a 3% return, but everything you buy is 3% more expensive, in practical terms you haven’t gained anything at all. That doesn’t mean you should avoid bonds when real rates are zero or negative, but it certainly makes them less appealing.

Let’s start this analysis by figuring the real rate for Treasury bonds. To simplify, let’s assume the 10-year bond yields 4.25%. (It’s been in that general range since mid-2023.) Annualized inflation, as of the March release, was 2.4%, but there was an unusual 6% drop in gas prices, so let’s average out the first three full months of the year for a more accurate number. When we do this we get a 2.75% rate. So the real Treasury rate is a paltry 1.5%.

This is low, but certainly not an insult. So why do I say that rates are a joke? There are a few reasons.

Inflation isn’t going away.

Despite the optimistic reading in March, inflation has persistently remained in the economy for years longer than it was supposed to. After aggressively hiking interest rates and turning their asset-buying program into an asset-selling program, the Fed was ready to declare victory—but the real world didn’t cooperate. Inflation is now what we would consider “sticky”.

Some of it is muscle memory, some of it is corporate greed—fulfilled by Americans’ perpetual willingness to spend money, even on stuff they can’t afford. There is a budget deficit, which is usually inflationary but somehow wasn’t between 2008 and 2021—now it is. Some of it’s due to the labor market: even despite DOGE’s depredations, there are more open jobs than at any time in the twenty years before the pandemic. The labor force realigned in 2020: some people retired early, some people dropped out, and the reality we were used to (jobs are hard to find) turned on its head. This change in negotiating posture has led to consistent wage inflation. Wage inflation is always and everywhere a significant driver of price inflation. (This change in the labor market is seldom discussed by the mainstream financial media despite being perhaps the most important post-pandemic economic development.)

Even with this inflationary storm brewing, more dark clouds are on the way. The Trump administration seeks to widen the deficit even more by cutting taxes, which will fuel inflation. Trump himself wants lower rates, and will get the opportunity to replace the implacable Jerome Powell with someone less resolute next year. Most problematically, the tariffs announced on “Liberation Day” will make just about everything more expensive. So that real rate of 1.5% might not be around long.

Default risk isn’t zero.

The constant media panic involved with the debt ceiling has been postponed until September. However, the political brinksmanship that occurs every time the limit is reached has a significant impact on the US’s creditworthiness and already resulted in a credit rating downgrade by Fitch in 2023. Even if default is unlikely (and as long as cooler heads prevail, it is), the spectacle makes the US a worse borrower, and hence has some upward impact on rates.

The US gets a special borrowing discount.

As the world’s reserve currency and a country with outstanding creditworthiness, the good old US of A gets perks in the bond market that nobody else does. Despite the various issues plaguing our government, we are considered a “safe haven”, which puts a major damper on rates.

When you lend money to the government (which, for those who don’t know, is what happens when you buy a Treasury), you’re competing for the opportunity to lend with a variety of foreign investors. Some of these investors live in countries where yields are low (in most developed countries, they’re lower than ours). Others live in countries with unstable governments. The US sucks in capital from these countries and gets lower rates because of it. As long as that system’s in place, Treasury rates will remain artificially low.

Summary

We hope we’ve presented sufficient evidence that buying a 10 year bond at 4% and change just isn’t a good investment. While the best strategy is always an individual one, Roth Research generally recommends waiting to invest in long-term bonds until rates make a bit more sense (5% for the 10 year would be a start). The pain of this decision is greatly mitigated by the high yields offered by shorter-term bonds, such as the six month note, whose yield is nearly as high as the 10 year.

Let’s wrap up with a chart of yields over the last 60 years to reinforce the point that before 2008, these yields would have been seen as low, not high.