In this era of ultra low yields and modest inflation, investors often don’t think twice before buying longer term bonds to get a boost in yield. Inflation can negatively affect the return of any investment, but the combination of long terms and often low nominal yields in treasury land opens the door for negative real returns.

For the purposes of this research I made a few assumptions. First I assumed the constant maturity 10-year Treasury was purchased at the end of the month, and held for the entire ten-year term. The real return shown in the graph below is the yield as of the purchase date, minus the average annual compounded rate of inflation over the next ten-years. The red dot represents the last point of true inflation data. Every point to the right of the dot assumes that the average rate of inflation during the period will continue until the bond matures. Because of the extrapolation, the data becomes less useful as it moves farther to the right of the dot. But I just didn’t want a graph that stops in 2001.

The data tells a pretty interesting story I think. The 60’s and early 70’s were dominated by periods where inflation over the following ten-years consistently outpaced bond yields, resulting in negative real returns. Yields adjusted for higher inflation in the late 70’s, and while inflation died down in the late eighties, bonds purchased before that at yields from 12-16% outperformed inflation by the widest margin during the sample period. Inflation has stayed very tame during the last twenty-years, while Treasury yields have steadily fallen from their highs in the early 80’s.

The ten-year Treasury has been trading around a 3% yield recently, while expectations for inflation, (as measured by ten-year TIPS breakeven yields), hover around 2.3%. That .7% expected real yield, (which happens to match the current real yield on the ten-year TIP), is quite a bit lower than the average realized real yield over the sample period of 2.85%.

Have a great weekend. 

Cliff J. Reynolds Jr., Investment Analyst