Twice a year we undertake an analysis of real interest rates for our publications Consensus Forecasts – G7 and Western Europe and Asia Pacific Consensus Forecasts (in May and November) and the resulting tables and analysis are displayed in both the hard-copy and PDF versions of the publications. Our analysis focuses on both short-term and long-term interest rate expectations.

 

 

The table below shows a portion of the data from one of our surveys for 10-Year Real Interest Rates (from our May 2022 Consensus Forecasts – G7 and Western Europe survey), together with some written analysis from the same publication.

 

 

 

Our regular analysis of real, i.e. inflation-adjusted, interest rates in 12 of the world’s industrialised economies compares the range of current long-term 10-year government bond yields (see table above) with levels from our survey of six months ago (chart, right). From a long-term historical perspective, an economic paper published in 2016 by the US Federal Reserve Bank of Minneapolis, Real Interest Rates over the Long Run, showed that long-term interest rates in increasingly integrated G-7 capital markets have been converging toward low or negative levels since the 1980s. However, this scenario has lately been overturned. The bond market outlook is being driven by significantly higher inflation, not just for this year, but also over the 10-year forecast horizon (albeit at more modest rates of inflation). Bond traders are already declaring this the beginning of a bear market as central banks start hiking interest rates after an extended period of ultra-accommodative monetary conditions.

Before the Great Financial Crisis of 2008, central banks targeted inflation directly to maintain the value of currencies, savings, assets and bonds. Over a decade of quantitative easing (QE), not to mention record-high public debt, expanded central bank mandates to encompass other targets. But with some sovereign bond markets now pricing in somewhat higher inflationary expectations for the longer-term as well as the shorter-term, the onus is back on inflation. The chart above shows real bond yields starting to surge from exceptionally negative levels to the 0% bound. Most inflation-adjusted yields remain below the 0% bound, especially when inflation itself is expected to accelerate, but some (Italy, Canada, Norway) have broken into positive territory, even with priced-in inflation expectations. Germany and the Netherlands’ are particularly low, due to the notable increase in their 10-year inflation expectations compared with those formulated in November 2021. With central banks appearing to have been outpaced by the speed of inflation in the G7 & Western Europe (especially in the aftermath of the Ukraine invasion), nominal 10-year government bond yields will likely continue rising.

A portion of text from Consensus Forecasts – G7 and Western Europe, May 9, 2022.