Where are Long Bond Yields Going: Late 70's / Early 80's Edition

But the money shot is that when the yield curve has been VERY steep (i.e. more than 4%) the Long Bond has rallied in all cases (19 out of 19 times) over the next year.

This is a great observation! One caveat though: the data is taken during a period of time where the 30-year bond yield DECLINED consistently (the data was from 1986-2009). This observation would be more reliable if it includes 1960-1980 where the 30-year bond yield ROSE.

If we're experiencing a regime change today, then the relationship likely won't hold.

And he is correct that rates rose DRAMATICALLY from the late 1970's through the early 1980's (the Long Bond only started trading in 1977). Looking at the data from 1977-1985 (i.e. the time frame that took place before my post), we have the following:

Note that the yield curve was only as steep as it is now (i.e. more than 4%) for a brief period in 1982 and the steepness (i.e. spread between 30 Year Treasuries and 3-Month T-Bills) was much more volatile during the above time frame than since. We can also see the spike in this steepness from April - October 1980 when 3-Month T-Bill rates dropped dramatically (the data is from the Federal Reserve, but not sure why this happened), only to rise within 6 months. Anyone know what was going on?

And below we show an updated chart showing the steepness of the yield curve on the x-axis and the change in the 30 year yield, one year forward, on the y-axis for the 1977-1985 time frame (each point represents an end of month figure).

What do we see? I would say the overall theme is unchanged. When the yield curve is VERY steep rates move down in more cases than up. When Long Bond rates were rising dramatically, it was in a number of cases led by a rise in the short rates (in response to inflation and/or an attempt to stomp out inflation), which resulted in the yield curve to be inverted. The outlier was that odd period from April 1980 - October 1980 when 3 Month rates crashed for a reason I am not aware.

In summary, when the market historical priced-in inflation into long yields, it typically also priced-in inflation in short yields. The idea that short-term deflation is a potential outcome, while at the same time long-term inflation is a potential outcome is an outlier event.

In other words, history can not necessarily help us with what to expect.