In Our Elevator Pitch For Bonds, we ask, “is this time different.”
Our view of the attractiveness of bonds can be honed into an elevator pitch. It essentially boils down to a straightforward question – Is this time different?
Have the forty-year pre-pandemic economic trends reversed, and the economy’s inner workings changed permanently over the last three years? expectations
More specifically, are slowing productivity growth, weakening demographics, and rising debt levels about to reverse their prior trends and become a tailwind for economic growth?
NO, this time is not different. Yesterday’s economic headwinds have not vanished. They will eventually overcome the massive pandemic-related stimulus that continues to prop up the economy.
This article employs a classic bond model that allows us to solve for the expected economic growth as implied by bond yields. As you will see, the bond market believes economic growth will be significantly higher than expectations for the last 20 years. If they are correct and this time is different, current bond yields may be fair or even too low. However, if this time is not different, the market is grossly offside in its growth expectations, and bond yields are too high.
Decomposing Bond Yields
U.S. Treasury bond yields are a function of three factors: term premium, inflation, and economic growth expectations. Because Treasury securities are considered risk-free, credit risk is not a factor. For more on that, please read our recent article, Risk Free Government Debt- Fact Or Fiction.
Term premium, also called term premia, is the amount by which the yield of a long-term bond exceeds the expected yields of short-term bonds. It quantifies the amount investors expect to be compensated for committing to one long-term interest rate versus a series of shorter-term interest rates.
Term premia is not an