Long-term bond yields have been constantly testing new highs globally in the past two years (after finding a low following the Covid-19 shock) as inflationary pressures have been surging, particularly in recent months. While EM central banks (particularly Latam/CEEMEA ex-Turkey) have been hiking aggressively in the past year to tame inflation and limit the downside risk on the local currency, DM central banks have kept interest rates low in order to keep financial conditions as loose as possible to stimulate the economic recovery.
As the Ukraine war combined with the global supply chain disruptions (amid China renewed lockdown policies) will add on to the already existing inflationary pressures, DM central banks are likely to accelerate the tightening process this year, increasing the recession risk (particularly in Europe). The expected aggressive tightening by DM central banks is likely to lead to new highs in LT yields, questioning investors on how far LT bond yields can rise without ‘breaking’ the market.
Figure 1 represents the history of interest rates since the beginning of the 12th century up to today. The data source comes from Homer and Sylla’s book A History of Interest Rates (2005), which reviews interest rate trends in the major economies over four millennia of economic history. For the last 150 years, we compute a GDP-weighted average interest rate times series using a sample of 17 countries (Global LT interest Rate), using data from Jorda et al. paper The Rate of Return on Everything (2017).
Our global measure of LT bond yields is already up 112bps this year to 2.12%, and the historical average of LT bond yields stand between 4 and 5 percent (looking at hundreds of years of data). Will LT interest rates retrace towards their historical mean, or will the ‘deflationary forces’ win again?
Figure 1. A History of Interest Rates