According to a widely reprinted and circulated report in the Wall Street Journal, for the first time since 2000, U.S. government bonds now yield more than all of their developed world counterparts. Looking just at the 10-year security, the yield on the benchmark Treasury note now yields more compared to a record number of countries, and the yield differential between the U.S. government note and its German bund counterpart is its widest in almost 30 years.
Basically, this means that the arguably safest investment available anywhere in the world – the one American business schools still hold up as a “riskless” benchmark – yields way more than most other sovereign debt, including Italy’s, Canada’s and Australia’s – but no, not Greece’s, although they’re not too far off.
Let’s look at the numbers.
As of May 22, the 10-year U.S. Treasury note was yielding 3.06%. Since breaking through the 3.0% barrier on May 14, the yield has remained mostly above that level ever since, hitting a high of 3.12% on May 17. That’s the first time the yield has stayed above the 3.0% level more than a day or so since 2011. While the yield has since come back down recently to below 3.0%, I think it’s more likely to hit 3.10% again before it moves much below 3.0%.
So how does that stack up to other developed country sovereign bond yields?
Using May 22 closing levels, the German bund – the benchmark for the eurozone – yields just 0.56%, or 250 basis points below the U.S. note. The Japanese 10-year bond yields just 0.05%. Elsewhere, 10-year U.K. gilts yield 1.52% -- half of what Uncle Sam pays – and Swiss bonds yield just 0.10%. Greece is at 4.39%, although that’s down sharply from recent years.
Even yields on Italian sovereign bonds, which have recently soared as an anti-establishment coalition seeks to form a government and return Italy to its financially-profligate ways, are way lower than their U.S. counterparts. The 10-year Italian government bond was recently trading at more than 2.40%, its highest level in four years. And yet it still yields a good 60 bps below what full faith and credit U.S. bonds yield.
Does this make sense?
Well, yes and yes.
Interest rates and bond yields, as we know, are a product of not only credit risk but also supply and demand and the cost of money. The U.S. passes the credit risk test with flying colors – not because our government is so fiscally responsible (it surely isn’t) but because it has the power to tax its citizens and businesses as much as it can get away with or, when that fails or isn’t enough, print and borrow more money. Few nations on earth can get away with that without creating hyperinflation.
Which leads to the second factor, supply and demand, and that’s where we see the reason for high U.S. borrowing rates.
Uncle Sam is in debt by more than $21 trillion, far and away the most of any nation on earth. Indeed, America’s external debt is larger than the next three countries’ total combined: the U.K. at $8.5 trillion, France at $5.7 trillion, and Germany at $5.4 trillion.
In other words, the world is flooded with U.S. government debt. There’s obviously a price to pay to get people to buy it all.
Actually, the U.S. is pretty fiscally responsible compared to its developed world counterparts. That $21 trillion in external debt roughly equals the size of U.S. GDP. That’s a trivial percentage compared to 313% for the U.K., 213% for France, and 141% for Germany. Surprisingly, Italy’s sovereign debt to GDP ratio is only 124%.
Of course, there’s another big factor that puts upward pressure on U.S. yields, and that is monetary policy. While the U.S. has pretty much moved past the financial crisis and the Federal Reserve has at least started the process of raising interest rates and unwinding its massive balance sheet, the rest of the world still acts like their economies are in dire straits.
For example, the European Central Bank’s main interest rates are still at their record lows set two years ago, with the deposit facility at negative 0.40% and its main refinancing rate at zero. The Bank of Japan’s key short-term interest rate remains at a record negative 0.10%. Both central banks have shown no indication when they might start raising rates or unwinding their own giant bond portfolios. The Bank of England raised its short-term rate last November but hasn’t made any similar moves since.
In other words, while the Fed is trying to normalize monetary and interest rate policies, albeit very slowly, the rest of the developed world shows no inclination to follow along. Interest rates are being kept deliberately and artificially low, and may remain that way for who knows how long?
So what’s the takeaway from all this? Despite falling this week, I think U.S. interest rates and government bond yields are likely headed higher, which will make the yield differential with the rest of the world even wider. With practically no credit risk, U.S. government bonds appear to present tremendous value, at least against their global counterparts.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.