Treasury investors are losing more money than they have in four decades, once inflation is taken into account. And if markets are right, they’re unlikely to come out ahead for years.
The federal government’s debt has already lost about 2% outright over the past year as the Federal Reserve started removing pandemic-era stimulus from the economy and inched closer toward raising interest rates. But on top of that, the consumer price index has surged 6.8%, putting investors even deeper in the hole.
Taken together, that’s resulting in the worst real returns -- or those adjusted for inflation -- since the early 1980s, when then Fed Chair Paul Volcker was in the midst of fighting a wage-price spiral. What’s more, the dynamic isn’t expected to change: The bond market is projecting that 10-year Treasury yields will hold below the inflation rate for the next decade, meaning any investment income will be more than wiped out by the rising cost of living.
The persistently low level of long-term yields in the face of the steepest inflation in decades has been a major puzzle on Wall Street, since it defies the textbook expectation that investors would demand higher payouts in return. In 1982, last time year-on-year inflation surged as much as it did in November, the 10-year yield climbed as high as nearly 15%. It’s around 1.5% now.
Some say that reflects the deluge of stimulus and rising household savings since the onset of the pandemic, which has left a surfeit of cash flooding into the Treasury market. For others, it reflects a pessimistic view of the economy, signaling that investors see the nation’s growth potential continuing to slip under an aging population.
Either way, nearly two years of sub-zero real yields have penalized average savers and bond investors to the benefit of the federal government.
“People have accepted negative real returns for a long period of time,” said Greg Whiteley, portfolio manager at DoubleLine Group, which oversees $137 billion in assets. “Despite the fact it may seem peculiar, maybe this is something we have to adjust to as the new normal. The long-term secular drivers are still in place, and they are still going to be powerful.”
Ten-year yields on inflation-linked bonds fell to an all-time low of minus 1.25% last month before rebounding to about minus 1%. Taken at face value, that shows investors expect 10-year yields to trail inflation by about 1% annually over the next decade.
“You many not want to own bonds because they are negative-yielding security,” said Francis Scotland, director for global macro research at Brandywine Global, which manages $67 billion in assets. “But that phenomenon may exist for a long time because of this fundamental disequilibrium between saving and investment, or spending and saving.”
Even so, there are some temporary factors at work. While the Fed has started paring its bond purchases, it’s still buying $60 billion worth of Treasuries a month. All told, the central bank has absorbed more than $3 trillion of Treasuries since February 2020, taking the pressure off public buyers. Meanwhile, many pension funds are almost fully funded for the first time since 2008, thanks to the stock rally, giving them incentives to buy fixed-income to reduce the risk exposure in their portfolio.