Long term interest rates vs nominal GDP growth redux

Back in Q1 2015 we published an article looking at the long-term relationships between 10 year bond rates and nominal GDP. Economic theory suggests on average risk free interest rates (proxied by the 10 year bond rate) should match the long-term nominal growth rate in the economy (proxied by nominal GDP).

In our 2015 article we provided two graphs of this relationship since the 1970s – one for the US and the other for Australia. These charts showed the relationship had held pretty well over time – but over the last few years a big gap had opened up – with 10 year bond rates well below nominal GDP. See below for the charts from our 2015 article.

In the 3½ years since, rates have remained low. However, US rates have moved up decisively over the past 6 months and now have closed the gap with nominal GDP – see the chart below. Score 1 for economic theory!

However, the theory doesn’t seem to apply in Australia. While Australian 10 year bond rates have moved up modestly compared to their all-time lows, they are still well below the levels implied by trends in nominal GDP growth.

The interesting question is will this gap close, and if so, will it be due to higher bond rates, lower GDP growth or lower inflation. These are important questions for infrastructure investors.

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