The unexpected outcome and potential consequences of the U.S. presidential election continue to shake financial markets. Nowhere is this more so than the U.S. bond market.
Yields on the 10-year Treasury are up 50 basis points (bps, or 0.50%) since the election and nearly 100 bps from the July lows, as bonds sold off. This marks the fastest rise since the so-called “taper tantrum” in 2013, when expectations of an increase in interest rates by the Federal Reserve triggered a bond selloff.
After such a sharp selloff in bonds, we could arguably see markets settle down and prices stabilize for a bit. But over the long term, I would argue the selloff in bonds—and corresponding rise in yields—will continue for two basic reasons:
Higher nominal GDP growth going forward
Whether the new administration’s policies lead to faster economic real growth(after inflation) is an open question. But they are almost certain to lead to faster nominal growth, which includes inflation. This is important because over the long term it is nominal growth that drives rates. Going back to 1962, nominal growth has explained roughly 35% of the variation in U.S. 10-year Treasury yields (see the accompanying chart). Roughly speaking, 10-year yields increase 50 bps for every one percentage point increase in nominal growth.
Today, nominal growth is slightly under 3%. To put that number in perspective, prior to the 2008 financial crisis nominal growth averaged better than 7%, including during recessionary periods. A modest rebound back toward the upper end of the post-crisis range would thus suggest a rise in 10-year yields back to approximately 5%. While an increase that high is unlikely given structural headwinds (such as demographics and the deflationary impact of technology), it suggests yields still have further to rise.