The Truth About Bond Yields

We have a winner!

In a bit of a nail biter, current heavyweight Fed Chairman Jerome Powell faced off against chairmanship challenger and Fed Board Member Lael Brainard. 

Chairman Powell has shown himself to be more hawkish when it comes to inflation — or at least more willing to sound like a hawk. (There hasn’t been an actual inflation hawk in the Fed since Paul Volcker.)

Brainard on the other hand has been described as “an uber-dove when it comes to monetary policy and a closet proponent of Modern Monetary Theory.

Easy money always makes the markets happy. On the other hand, one has to maintain some semblance of monetary sanity (for now at least).

When the dust settled, Joe Biden renominated Jerome Powell to wear the heavyweight belt for the next 4 years. As a consolation prize, Brainard was nominated for the number two spot of Vice Chairman — so you can pretty much guess the direction we’re headed.

Markets breathed a sigh of relief, because the devil you know is always (almost) better than the devil you don’t. 

This nomination really was kind of a big deal for bonds because it gives the market a sense of how negative interest rates could be going in the future.

Yeah… negative


For the past dozen years or so — since back in the Great Recession as we’ll all tell it to our grandkids — the Federal Reserve has promoted a policy of zero interest rates (ZIRP for short). It’s really a policy of near-zero interest rates designed to get banks to spread liquidity around the economy. You’ve seen this chart before. 

Federal Funds Rate

It’s the Fed Funds rate since 1980. The trend since then is obvious. And with the exception of one brief attempt at normalization, the rate has been kept near zero since 2009. Currently the Fed Funds rate is floating around a whopping 0.08%. 

But for some, zero is not enough.

Enter NIRP.

While negative interest rate policies (NIRP) are sometimes talked about in the media like they’re something central banks use on a regular basis, the truth is, they’re not. 

Higher interest rates discourage borrowing and encourage saving. Based on that logic, negative rates should have the opposite effect — discouraging saving and encouraging borrowing (and ultimately spending). In theory, it’s a strategy to fight deflationary periods — the bad times when people hoard cash waiting to see if things get better. (Not the inflationary hurricane we appear to be headed into.)

Greg McBride, chief financial analyst at calls negative interest rates “…the central bank equivalent of throwing something against the wall to see if it sticks…They are still nothing more than an experiment.”

David Lebovitz, global market strategist at J.P. Morgan Asset Management, puts it a little more succinctly, “A negative rate means you are more concerned with the return of capital rather than the return on capital.” (Emphasis ours.)

Nevertheless Japan, Switzerland, and Denmark are three countries whose base rates currently dip south of zero. 

Back here at home, the Fed hasn’t formally announced the adoption of a negative interest rate policy. But for all intents and purposes they’ve been implementing it in secret for over a year. 

Nominal vs Real Interest Rates

In the world of finance, there are two kinds of returns — nominal and real.

Nominal is what you get paid.

Real is what you keep.

It’s like gross versus net income: Your job pays you $10,000 each month but the government takes their cut first. So maybe you walk away with only $7,500.

It’s the same in the financial markets. Say you buy a bond (or any income producing asset) and it pays you 1.505% (That’s the 10-year yield as of this morning). That means every year on a $1,000 bond you’ll earn $15.05 for the next 10 years. 

Nothing to write home about.

But consider, prices are rising at an annual rate of 6.2% (according to last month’s CPI report).

Your money is growing at 1.51% while the prices of everything you have to pay for are rising by over 6%. The math can’t be any clearer…

And the Fed has been complicit in creating this situation.

When global economies seized up last year, the Fed went on a massive bond buying spree in all areas of fixed income markets. They slashed rates. Pumped trillions into the economy through things like emergency loans. Started buying $120 billion of Treasury and mortgage-backed securities every month. They even started buying corporate and municipal bonds and ETFs.

This action put a major squeeze on yields. And since inflation hasn’t yet proved itself to be transitory… surprise surprise!

The chart below is the 10-Year 0.875% Treasury Inflation-Protected Note issued in January 2019…

Real yields have been pushed into negative territory. 

The bond market is broken… kaput! And you’re paying the price.

Faced with the prospects of economic downturns, the Fed reacted like it always does. Preparing (theoretically) for deflationary forces that would trigger a recession.

The question is, how much worse does this get before (or if) it ever gets better?

But there’s a bigger issue in play here. And the Fed’s motivation is something entirely different. 

Next week we’ll be publishing your December issue of Streetlight Confidential. But in your next weekly update I’m going to expand in a little more depth on what the Fed’s ultimate goals may actually be.

Stay tuned and…

Make the trend your friend,

Bob Byrne
Editor, Streetlight Confidential