Two Lost Decades
Bryan Taylor, Chief Economist, Global Financial Data
In a previous article entitled “The Lost Decade” we discussed the horrible returns that fixed-income investors have received during the past two years. After inflation, investors in 10-year U.S. Government Bonds lost 38% of their investment between 2021 and 2022. We concluded that fixed-income investors are unlikely to make back those two years of losses by the end of the decade creating a Lost Decade for fixed-income investors. In the article we observed that during the past 225 years in the United States, there has never been three successive years in which fixed-income investors lost money but given the recent rise in yields on 10-year government bonds, and the decline in bond prices that accompanied that, the markets might break this record and provide investors with a third year of losses.
Figure 1. United States 10-year Government Bond Yield, 1950 to 2023
Just to review, U.S. 10-year Government Bond investors had nominal losses of 3.93% in 2021 and 17% in 2022. This was accompanied by inflation rates of 7% in 2021 and 6.5% in 2022. After adjusting for inflation, fixed-income investors lost 11.2% in 2021 and 24.6% in 2022 for a cumulative loss of 38.6% in 2021 and 2022. That loss is worse than equity markets often provide. The yield on the 10-year government bond rose from 0.93% in December 2020 to 1.52% in December 2021 and to 3.88% in December 2022. Bond yields declined until April 2023 and have risen since then. Yields rose during 2023 because the Fed has extended the time period it plans to keep interest rates high since the economy has remained strong despite raising the Fed Funds rate from 0-0.25% to 5.25-5.50%. The 10-year bond yield rose to 4.59% at the end of September and hit 4.81% on October 3. Through the end of September, bonds had lost 2.58% during 2023. By our calculations, if yields close above 4.33% by the end of the year, fixed-income investors will face a third year of losses, and that is before adjusting for inflation.
In reality, fixed-income investors have already suffered through a lost decade. GFD’s Total Return Index of 10-year government bonds was at 9422 in May 2012 which is more than the 9291 the index stood at in September 2023. Between May 2012 and August 2023, consumer prices rose by 33.6% so in real terms the loss was even greater.
Although we are singing the fixed-income blues today, you have to remember that these losses come at the end of four decades of fabulous returns to U.S. government bonds. Between 1981 and 2021, bonds returned 7.65% in nominal terms and 4.98% after inflation on an annual basis as yields fell from 13.98% in 1981 to 1.52% in 2021. This works out to a 20-fold nominal return between 1981 and 2021. $100 invested in U.S. government 10-year bonds in 1981 would have grown to $2000 by 2021.
If a third year of losses seems likely, could a fourth year of losses occur in 2024? It seems unlikely. Bond yields would need to approach 6% by the end of 2024 for this to happen. Because of the Fed’s intervention in the economy, inflation rates are no longer rising. Inflation is headed for 3%, not 5% or higher. As inflation moderates and the prospect of the Fed continuing to raise the Fed Funds Rate diminishes, bond yields will stop rising and may even decline.
The 10-year government bond index has lost 24% during the past three years while consumer prices have risen by 18% producing a 46% loss between September 2020 and September 2023 after inflation. If you assume an average bond yield of 4% between now and the end of the decade, it will take six years to make back the losses between 2021 and 2023 and over eleven years to make back the losses after inflation. It may take to at least 2029 to restore fixed-income investors to where they were at in 2019. Someone investing in 10-year government bonds in 2012 would just break even by 2029 or 2032.
So instead of talking about a lost decade, it looks like we may be talking about two lost decades.
