Global, Not Term Premiums: What Low Yields Really Say

The standard explanation for low bond yields has been driven by – who else? – Ben Bernanke summing up the view from econometrics. Term premiums, he says, these made-up decomposition components which only allow for QE to save a tiny bit of its face. In other words, QE obviously didn’t lead to recovery, it sure didn’t create modest let alone overheated inflation, and only the most favorable studies can find a rather underwhelming contribution to lower interest rates (because the market does the vast majority of the lowering, if not all of it).

What’s left by which to claim some minimum of success if you’re a QE practitioner? Bernanke in 2015:

What about the decline in longer-term yields since early 2014? In the US at least, that decline is somewhat surprising, as economic fundamentals have recently seemed more consistent with rising, not falling, longer-term yields… By the process of elimination, with fundamentals stable or improving, much of the decline in yields over the past year must reflect a sharp drop in term premiums. [emphasis added]

That’s the thing about term premiums; they’re entirely fictional, the remainder after statistical models attempt to dissect interest rates into a couple of parts. What if those decompositions aren’t the whole story?

The problem for Bernanke, as Yellen and the whole mainstream, in 2015 (and again in 2018) was that it seemed like all the negative fuss was deposited somewhere else than the US (“overseas turmoil”, as it was called back then).

For bond yields, then, it would seem sensitivity to fundamentals not exclusively domestic. Term premiums or not, lower yields were reflecting global setbacks and the rising probabilities of more and worse ones. Maybe the US wouldn’t fare as badly (it didn’t, but it wasn’t unscathed, either) but that’s not what drove UST yields then nor would it be in them now.

Global Economy and the global money which drives it (repeatedly into the ditch).

Economists, however, approach this very differently – which is a kind way of saying wholly incorrect for all the wrong reasons. They think the domestic US economy is a largely a closed system, therefore UST yields reflect only those factors and from that they break down Treasury yields.

They have to do it this way otherwise their DSGE models would be made worthless (they are worthless, but by fooling themselves they can pretend R* or something). I wrote in August 2019 when many of them were quick to dismiss the UST curve inversion as anything other than what it had been:

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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