The Continued Low Interest Environment

U.S. Treasury rates continue at historic lows, across virtually the entire yield curve. Further, corporate bond yields have also been declining as of late. Indeed, except for the months just after the financial crisis in late-2008, rates have declined steadily over the past 5 years. For example, the Industrial A-rated 10-year bond yield has declined from just over 6% in mid-2007 to 2.57% as of July 31, 2012, and the 20-year bond yield has declined from just over 6.25% in to 3.83% over that same span. Yields for other corporate bond credit risks have declined in similar fashion.

Further, while for many years economists have been predicting a turnaround in this environment, more are now estimating that these low rates are here to stay for some time, due to:

  • Continued uncertainty in the Euro Zone and slower growth in China, and the resulting flight to the relative quality of U.S. Treasury and Corporate bonds
  • Continued modest or flat growth in the U.S. economy, requiring less new capital
  • A continuing pattern of "deleveraging" in the United States--both corporations and individuals have been steadily reducing their debt as it relates to GDP

The first trend means more cash chasing the supply of bonds, leading to lower yields, and the last two mean less competition for investors' money, leading again to lower yields.

Longer-range forecasts, mostly in the form of rates implied by the current U.S. Treasury yield curve, indicate that, over the next 5 years, yields at the short end of the curve will increase by just under 200 basis points, the 10-year rate will increase by about 100 basis points, and the 20-year rate will increase by about 60 basis points. This, of course, assumes that the Fed's efforts to hold down interest yields will not continue for another 5 years. Based upon this and current credit risk spreads, by the end of this forecast period investment grade corporate bond yields would still likely be not much above 5%. Further, it is worth pointing out that this proxy measure, the "Forward Yield Curve," has not been a very good predictor of interest rates for the past several years.

GBC monitors these trends, and currently reflects them in our product pricing and actuarial forecast assumptions; we will continue to keep our clients apprised of this situation.

Below are links to additional recently-published articles regarding the low interest environment. (PIMCO's vision of a long period of low growth and correspondingly low yields) (a survey of 51 economists)

Also, if you have login credentials to A.M. Best's website, there was recently an interesting webcast on this topic, which can be found at Choose the link to "Economist A. Gary Shilling on Global Deleveraging and Investment Strategies for Insurance Companies"

Posted: August 27, 2012