The spread between the 10 -
year nominal bond and the 10 - year Treasury Inflation Protected bond - the markets estimate of annual inflation over the period - is about 250 basis points, up 50 basis points from a year ago.
Exhibit 3 shows the yield for 5 - and 10 -
year nominal bonds went down 30 bps and 54 bps, respectively, but we can see positive returns in the local indices.
Not exact matches
Other than that one time, over any ten
year period, long
bonds never showed a negative
nominal return.
Real
bond returns have been high over the past 30
years or so because
nominal starting yields were high and inflation has fallen.
Over the entire 101
years,
nominal (real) compounded returns for U.S. stocks,
bonds and bills were 10.1 % (6.7 %), 4.8 % (1.6 %) and 4.1 % (0.9 %), respectively.
Chapter 4 — International Capital Market History examines returns (
nominal and real) and volatilities of stocks,
bonds and bills across 16 countries for 101
years from 1900 to 2000.
Medium - term inflation expectations of financial market participants, as implied by the difference between
nominal and indexed
bond yields, have risen to around 3 per cent in October, from less than 2 per cent at the beginning of the
year.
For those that follow Treasury
bond fluctuations closely, it's been hard not to notice the persistent under performance in Treasury Inflation Protected Securities (TIPS) versus
nominal coupon
bonds over the last several
years.
The private sector economists are surveyed for only a selective number of aggregate economic and financial indicators: real gross domestic product (GDP) growth; GDP inflation,
nominal GDP;, the 3 - month treasury bill rate;, the 10 -
year government
bond rate;, the unemployment rate; the, consumer price index; the exchange rate (US cents / Cdn $); and finally, and U.S. real GDP growth.
Expectations of inflation, as measured by the difference between
nominal and indexed 10 -
year bond yields, remain at around 2.3 per cent.
Real yields have moved similarly to
nominal yields over the same period, with yields on 10 -
year inflation - linked
bonds currently around 3.5 per cent (Graph 52).
Despite the sharp rise in inflation expectations, 10 -
year breakevens (the difference between the yield on a
nominal fixed - rate
bond and the real yield on TIPS) remain depressed relative to their long - term history.
Average maturity for TIPS purchases is 14
years, versus 6.5 for
nominal bonds.
Now, we knew from the beginning that the Federal Reserve would buy the grand majority (94 %) of its
nominal bonds 10 -
years and shorter.
The 7 — 10
year range of the municipal
bond market has kept pace with U.S. Treasury
bonds and
nominal yields remain comparable to U.S. Treasury
bonds.
For example, a
bond with a face value of $ 1,000 that pays $ 100 per
year has a
nominal yield or coupon rate of 10 %.
Yet while
nominal bond yields have declined, the credit risk component of US Treasuries has been on an increasing trend since last
year.
If you believe inflation is going to be greater than 2.12 % over the next 10
years you would want to buy TIPS instead of
nominal bonds.
Theoretically the investor owning TIPS earn 1 % per
year less than would have been obtained from buying
nominal bonds.
Think of 1979 - 82: by the time
bond yields were nearing their peak levels,
bond managers were making money in
nominal terms with rates rising because the income from the coupons was so high, and it set up the tremendous rally in
bonds that would last for ~ 30
years or so.
Of course, even if rates climb from 2 % to 10 %, assuming that you keep the
bond to maturity and assuming that there is no applicable credit event, it will still pay out the same $ 1000 at maturity and the same $ 20 /
year (2 % of
nominal value $ 1000, p.a.).
The chart below shows the decline in the US Treasury yield over the last 21
years split between the real yield, as estimated by the Bloomberg Barclays US Inflation Linked
Bonds Average Annual Yield, and the level of inflation expectations implied by the 10 -
year nominal Treasury
Bond yield.
The yield on
nominal five -
year Treasury
bonds has been consistently below 2 percent since late June 2010.
To better understand this framework, let's look at an example of a 10 -
year fixed - rate US Treasury
bond (historically, without default) and compare the purchase yield to the total
nominal return.4
Subtract this rate from the yield on
nominal bonds - currently 4.75 percent for the 10 -
year note - for a measure of the inflation expected over the term of the
bond.
Yes you might, if you were hedging against
nominal Treasuries, with the CPI running ahead at 4 %, and short - dated (5
years and in)
nominal bonds at 2 1/2 % and lower.
In fact, Table 1 shows that investing in the 60/40 portfolio over more recent periods, the last 50 or even 25
years, resulted in even better annualized
nominal returns, with U.S.
bonds picking up some of the slack from a slightly lower U.S. equity market return.