Monetary Policy

This time is different – why 800 years of historical data can’t be wrong

By: Brandon Matsui | November 24, 2017

The changing of the guard of the U.S. Federal Reserve (fed) chair is a great time to reflect on where we are in the rates cycle. We are living in a world of historically low interest rates and talk of yields typically involve some version of “secular stagnation”, “lower for longer” or even the occasional Bond Bubble warnings. After thirty six years of falling rates how does one value today’s current yields? Is it a bubble? Can we use history as a guide to understanding how rates may move in the future?

The Bank of England’s research group analyzed this topic recently and published a fascinating piece where they studied 800 years of risk free global rates. 1By using data that stretches from 1273 to today, researchers show that the current global bond market does indeed show strong signs of a historically unusual price and the working paper goes on to warn investors that typically rate bear market cycles follow secular rate bull markets.

The Bank of England researchers used a creative bootstrapping technique to link the world’s global nominal risk free rate starting in 1273 with Venician lending rates, moving to Genoa, then to Spain, and so on until 1981 when the 10 year U.S. Treasury became the world’s risk free benchmark. The authors found that the ongoing secular bull market in U.S. Treasuries (from 1981) is the longest bull-run in 300 years, the third longest on record and the second-most intense (as measured by annual yield compression in basis points). Moreover, the researchers found that the global risk-free rate fell to its lowest nominal level ever recorded in July of 2016.

Source: Bank Of England Staff Working Paper No. 686 Eight centuries of the risk-free rate: bond market reversals from the Venetians to the “VaR shock’ October 2017. May not be indicative of future results.

The research also shows that secular bull markets naturally lead to rate reversals. Further, the paper shows that instability in bond markets are often triggered by official Federal Reserve communication. As we prepare for a new Federal Reserve chairperson, it makes sense to consider the possibility of a change in official language and transparency, as well as the uncertainty generated by political interference causing a a prolonged increase in rates. Following thirty six years of trending lower rates there are reasons to expect a meaningful change in rates. The first reason is a concern that rising deficits and a looming Treasury supply surge will change the supply-demand equation to the detriment of bond prices. Second, solid fundamentals for growth and wage gains in the US should help boost inflation (bad for bonds). Finally, poor longer-term technicals (800 years of history showing that rates have hit bottom!).

What does it all mean? It is possible U.S. 10-yr rates will continue to move lower and this historic move in rates continues. That is the “secular stagnation” argument where we have permanently moved into a low growth low inflationary environment which our rates are reflective of. Alternatively we could be starting a fundamental reversal of the low rate regime. Given the change in leadership at the Federal Reserve (and the risks associated with Federal Reserve miscommunication) investors may want to prepare their portfolios for the possibility of higher rates. One way to do this is to consider interest rate hedged investments that offer exposure to major asset classes such as Investment Grade bonds, High Yield or Emerging Market debt. These products use futures to hedge interest rate risk thereby insulating investors from negative performance associated with higher rates but at the same time providing diversified asset class exposure and consistent coupon interest.

1Bank of England Website

Brandon Matsui
Fixed Income ETF Portfolio Manager
For general inquiries:
(844) 851-4255


Given the change in leadership at the Federal Reserve(and the risks associated with Federal Reserve miscommunication)
investors may want to prepare their portfolios for the possibility of higher rates.

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