Interest rates are set to move higher, but as Russ explains, we are still a long ways away from the long-term average of 6% 10-year Treasury yields.

The past month has witnessed a steady stream of developments supporting the likelihood of higher interest rates. Economic data has improved, tax cuts appear to be moving through Congress and investors are, for the first time in over a decade, contemplating a more hawkish Federal Reserve (Fed). All of which have led to a predictable backup in long-term rates.

As rates have risen, investors have, once again, started asking the perennial question: Is the bond bull market over and are rates normalizing? My view: It’s complicated.

Long-term drivers of yield

In thinking about bond yields, it is important to keep longer-term factors in mind that have nothing to do with central bank policy. Low yields have correlated with two, related longer-term trends: low nominal GDP (NGDP) and an aging population. The reason they’re related is that an aging population means slower growth in the workforce, and in turn, slower economic growth.

An aging population impacts rates through a second mechanism. As consumers age, their borrowing and investing patterns shift. Older households tend to borrow less and demonstrate a preference for income, in the process raising the demand and lowering the supply of bonds. The net result is that older populations tend to be associated with lower real, or inflation-adjusted interest rates. This dynamic has been at work for decades and helps explain why low yields predated the financial crisis.