Biggest Yield-GDP Gap Since 1966 Shows Room for Bond Pain
A 50 subject uncut sheet of $1 dollar notes. (Photographer: Andrew Harrer/Bloomberg)

Biggest Yield-GDP Gap Since 1966 Shows Room for Bond Pain

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Even with the recent spike that saw the 10-year rate top 1.6%, Treasury yields haven’t been this low relative to U.S. economic growth estimates since 1966. That suggests the climb in rates may still have room to run.

Analysts are boosting their growth and inflation forecasts, with Americans on the cusp of getting stimulus checks under President Joe Biden’s $1.9 trillion package. The average projection for nominal gross domestic product hit a 32-year high of 7.6% in Bloomberg surveys. Even after doubling to 1.6% since November, 10-year bond rates can barely keep up with the growth upgrade, leaving the gap between the two likely to be the largest since Lyndon Johnson was president.

Biggest Yield-GDP Gap Since 1966 Shows Room for Bond Pain

The global bond market has been hammered as prospects for stimulus and the Covid-19 vaccine rollout have spurred optimism toward an economic revival and higher inflation. Federal Reserve officials said rising yields reflect a stronger growth outlook and played down the need for a policy response, emboldening traders to push long-term borrowing costs even higher.

“I am bearish on the bond market,” said Julian Brigden, president of hedge-fund consultant Macro Intelligence 2 Partners. “We just have too much stimulus coming into the system. It’s going to combine the growth with a very rapid acceleration in inflation.”

While the relationship between bond rates and the economy isn’t stable, such a large divergence has been rare. Nominal GDP was less than 2 percentage points above 10-year yields on average in the decade through 2019.

“In the old days, bond yields should equal to nominal GDP,” said Brigden. “Things are very different now. But to what degree they are different? Can you have 1% negative real yield and 10% nominal GDP?”

Jeffrey Gundlach, founder of DoubleLine Capital LP, has noted before that Treasury yields should be comparable to the average of nominal U.S. GDP and German bund yields, a proxy for the level of interest rates in the international markets. By that measure, the comparable bond yields would be above 3%, should the consensus forecasts pan out.

While Gundlach cautioned to use his indicator only as a reference point, rather than a precise prediction, he used the metaphor of a dog tied to a stagecoach to describe the relationship between yields and GDP: A dog cannot really stray far away from the stagecoach. A spokesperson for Doubleline declined to comment on Gundlach’s latest thought on the market.

The economists’ consensus for nominal GDP is based on the average forecast of 5.5% for the real GDP and 2.1% for the PCE -- the Fed’s preferred inflation gauge. Goldman Sachs Group Inc. is among the firms that have boosted both their growth and yield forecasts, raising its year-end projection for 10-year Treasury yields last week to 1.90% from 1.50%.

Others, including Citigroup Inc. and Societe Generale SA, see it going to 2%.

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