The Future of Bonds: History Makes a Comeback

March 9, 2025

Economists, government finance officials, investment strategists and ordinary investors, seem to constantly obsess about where interest rates will be in the next quarter or year. This is understandable as portfolio management businesses depend on annual performance and fund managers like to keep their high paying jobs. There is prestige to be had for the market analyst whose rate call on a cable business channel, financial newspaper, or podcast proves to be prescient.

Human beings suffer from many cognitive biases which is defined by Wikipedia as “a systematic pattern of deviation from norm or rationality in judgment”. People involved in the financial markets are no less immune from these biases than anyone else. In fact, professional market participants have the added stress of constantly being in a bubble where conformity is rewarded, and free-thinking is viewed with suspicion, especially if the non-conformist is proven right.

Those observing the bond markets suffer a particular bias called “recency bias” which is a propensity of individuals to outweigh the importance of recent events when making decisions about the future. In practice, this is no big deal for economists and portfolio managers who are judged by their most recent calls, but this blind spot is dangerous for investors building and preserving their capital over a lifetime.

Currently, bond market participants and borrowers are making the mistake of believing that rates will return, sustainably, to their Great Financial Crisis to 2021 range. Not only were these yields the lowest in the history of civilization, but rates were below inflation, which had a disruptive effect on the economy. Much of the mess the world finds itself in right now is a result of this folly.

We are in a place where stepping back from the noise of the day and examining economic history can be elucidating. Economic history is not a popular subject as historians lack the understanding of economics and economists find it boring and irrelevant compared to preparing their briefs on the latest C.P.I. release.

An older colleague of mine lent me his copy of “A History of Interest Rates” by Sidney Homer, and Richard Sylla, originally published in 1963. It was the early 1990’s and I found the book fascinating, much to the amusement of my friends and colleagues. I looked at the yearly average yield of British gilts from about 1720 to 1918, and then did the same for U.S. Treasuries afterwards. I examined Treasury yields after the end of World War I when the U.S. dollar took over as the dominant world currency. Not coincidentally, the yield on U.S, dollar government bonds began trading below Gilts around the end of WWI. For most of our history, the global dominant currency, yielded below other countries. The current situation where U.S. Treasuries yield higher than other Western industrialized nations is rare. Do not let recency bias allow you to believe this will be permanent, unless the U.S. dollar is replaced. This may happen sooner than I would have expected only a few months ago thanks to the Trump administration’s trade and foreign policy.

I loaded the data unto a spread sheet and created a graph. Remarkably, rates from 1720 to about 1970 ranged from 2% to 6%, well over 90% of the time based on the annual average. The long-term average was almost exactly 4%. It was only from the beginning of the Great Inflation that began in the late 1960’s and became apparent in the early 1970’s to the Great Bond Bull Market from 1982 to the aftermath of the 2008 Crash that the market deviated to the historic range. We had rates rise above 6% and eventually go below 2%.

The 2% to 6% range with a 4% average lasted a very long time. The range held during double digit inflationary periods higher than the 1970’s and during periods of massive deflation. We have not experienced significant deflation since the Great Depression, but they were common before 1929 and led to civil strife and starvation. Yet despite our current view of the strong relationship between consumer prices and rates set by central bankers, the range held. Rates did not hit 20% during high inflation periods nor did they go negative during crashes and panics, as they were called then.

What does all this have to do with today’s fixed income investors? Quite a bit. In my opinion the economic world is returning to the environment more like the one that existed for centuries before. We are going from a free-trade-globalist model to, for better or worse, a protectionist-mercantile imperialism model. Trump’s strategy can be best understood as he intends to make America the dominant empire. Although, it might be less causal and more coincidental, I believe we are returning to a world where the 2% to 6% range, and 4% average will hold and the days of rates staying below inflation for numerous years is over.

There are significant long-term implications for investors. Bond investors can expect decent inflation adjusted returns that are not as volatile year over year as experienced in recent years. Bonds will no longer be a speculative asset. You probably won’t make a fortune in any given year, nor hopefully, will you see the value of your bonds crash, at least in nominal terms.

However, bonds will provide a good volatility dampener against stocks which are highly valued. Stable interest rates that are not artificially set below inflation means that stock markets are priced for earning perfection and fixed income yields are more competitive. P/E ratios will be lower than now over the long term.

Companies will no longer have the luxury of borrowing at low real rates making competition tougher and lowering expected profit growth. It will be more expensive for corporations to borrow which is more of a problem for chief financial officers of firms that issue bonds than corporate bond investors. Corporate government spreads may be higher on average and credit risk may be higher, all things being equal, but corporate bonds will do well especially in an environment dominated by E.T.F.s where investors are exposed to a diverse portfolio of companies, industries and even nations.

However, there is an important factor to consider. Despite what people may believe, current high U.S. rates may be more closer to our future than the low rates of other industrialized nations. Europe is re-arming and that will take capital. Going on a war footing usually results in more debt issuance, higher rates, and higher inflation. America has a debt-to G.D.P. ratio of over 120%. Given current Trump administration policies, debt-to-G.D.P. may rise. This would force the Treasury to pay higher for bonds than it anticipates or would like. About 30% of U.S. debt of $36 trillion is held outside the U.S. Investors, both foreign and domestic may just get Fed up.