Bond Real Yields: What’s Happening Beneath the Surface

Treasury bond yields have been drifting quietly lower since early June. But there is more going on beneath the surface than it might seem at first glance. Real yields—nominal yields less inflation—have declined steeply into negative territory. While nominal yields are near record-low levels from the deep economic decline, inflation expectations are picking up.

While nominal yields have been range-bound, real 10-year Treasury yields have been trending lower

Source: Bloomberg. 10-Year Treasury Inflation-Indexed Security, Constant Maturity, Percent, NSA (USGGT10YR Index) and 10-Year Treasury Constant Maturity Rate, NSA (USGG10YR Index). Daily data as of 8/18/2020. Past performance is no guarantee of future results.

If markets reflect the collective wisdom of investors, then the current message from the bond market seems muddled. Declining bond yields normally indicate that bond investors have a gloomy outlook on the economy. However, the message from the Treasury Inflation-Protected Securities (TIPS) market suggests that investors believe inflation risk is rising, a phenomenon usually associated with an overheating economy.

Despite the lack of evidence of inflation, expectations have been rising

Source: Bloomberg. U.S. Breakeven 10 Year (USGGBE10 Index) and U.S. Breakeven 5 Year (USGGBE05 Index). Daily data as of 8/18/2020. The breakeven rate is calculated as the difference between the yield of a nominal Treasury and the yield of a TIPS with a similar maturity. Past performance is no guarantee of future results.