Sunday, December 12, 2010

U.S. 10-Year Treasury Note Real Return History

This post graphs the history of "real" (i.e., inflation-adjusted) returns for investors in U.S. Treasury 10-Year Notes beginning in 1900.

100 Years of Treasury Note Interest Rate History documents U.S. interest rates over the past century based upon the rates in effect at the "time of issue" -- the "coupon rate." For buy and hold bond investors, that was also the investor's nominal rate of return.  However, because of inflation, the investor's real return is almost always less than the coupon rate. For short maturities, the investor's return is very close to that coupon rate -- again, assuming he holds to maturity. However, over a 10-year period, inflation can have a significant impact. In this post, we'll evaluate that impact.

10-Year Treasury Note Real Returns: The Impact of Inflation

graph of 10-year T-Bond inflation-adjusted returns (to 2012)
10-Year Treasury Note Real Returns

The above graph uses Robert Shiller's Irrational Exuberance data to approximate the historical "real" returns of investors in 10-year Treasury Notes from 1900 to 2002 (see
notes at end of post re sources). The solid green line shows my calculated return for investors who bought these hypothetical 10-year notes "when issued" and held to maturity; those returns have been inflation-adjusted. For reference, I also show the initial "coupon rate," or nominal rate of return.  (See About Nominal vs Real Returns.)

For example, according to Shiller's data, in January of 1900 interest rates were 3.15%. The first point on the dotted red line reflects that rate. To simplify the calculation, I assumed the buyer of a $100 Treasury (they don't really come in that denomination) would receive interest payments of $3.15 each year for 10 years -- at which time the bond would mature and the investor would have his principal returned. (note: I am compounding annually, not semi-annually.)

If you calculate the yield to maturity (YTM) for that set of cash flows, you'll get a YTM of 3.15% for a 10-year note issued in 1900. However, because of inflation over the next few years, the $3.15 received in "then current" 1903 dollars is only worth $2.87 in constant 1900 dollars. If you convert all cash flows associated with the 1900 note to constant 1900 dollar equivalents and then calculate the yield to maturity, the result is 1.0% -- the first point on the solid green line.

Each point on the green line, then, shows the real (as opposed to nominal) annualized return earned by an investor who bought a 10-year Treasury Note at the beginning of that year and held it to maturity. The YTM calculations are inflation-adjusted by converting all cash flows to constant 1900 dollars rather than using "then current" dollars.

Average Inflation-Adjusted 10-Year T-Note Returns

As you might have expected, the real returns earned were consistently below the initial coupon rate. The only exceptions occur around the time of the Great Depression. During this period, because of deflation, the value of some or all of the yearly interest payments was often higher than the original coupon rate, increasing the yield. (For more on this important period see The 1929 Stock Market Crash Revisited)

While the average coupon rate/nominal return was 4.9%, the average real return was only1.7%. Not surprisingly, the 3.2% difference between the two is the average inflation experienced for the century.

What's Going On?

To my way of thinking, the outstanding feature of this chart is the near-complete disconnect between initial coupon/nominal return and the real return for much of the century -- and the near-lockstep connection between the two beginning in 1982. Note that the difference between nominal and real returns is the same before and after 1981 -- it's about 3.2%; what has changed is the amount of variability.

Why? Some conjectures/a preliminary assessment: The impact of quantitative analysis and digital computing make today's financial environment considerably more sophisticated than that of 50 years ago, let alone a hundred years ago. The somewhat improved correlation between nominal and real returns from 1950-1982 may reflect, at least partially, the increasing use of these tools during that period.

Beginning in the early '80s, multiple additional factors come into play.  Potentially important factors that come to mind include: financial deregulation and the introduction of personal computers and spreadsheets in the early '80s, the growth of open & transparent primary and secondary markets for bonds, the growth of bond funds with the associated professional management, and, more recently, instantly available up-to-date information on the world wide web. The end result has been more sophisticated/accurate bond pricing and evaluation.

Related Materials
100 Years of Treasury Note Interest Rate History: graph of monthly interest rates/yield.
100 Years of Inflation History: graph of yearly inflation. O'view of impact on major asset classes.
Inflation Calculator/Spreadsheet: Calculates inflation rate between any 2 years, and converts dollars to equivalent purchasing power.
The Declining Value of a Dollar: Graph of change in dollar's value over time.
Yield to Maturity & Interest Rate Risk: How to calculate YTM.
100 Years of Inflation-Adjusted Housing Prices
100 Years of Inflation-Adjusted Dow closing prices: Closing prices since 1900 in 2010 dollars.
About Nominal vs. Real Rates of Return: intro to inflation
For lists of other popular posts and an index of bond & stock market posts, by subject area, see the sidebar to the left.
Pre-1953 interest rates & pre-1947 CPI data: Robert Shiller "Irrational Exuberance" data,
U.S. Government 10-Year Treasury Constant Maturity Rates (GS10 series): 1953 forward
U.S. Department of Labor Bureau of Labor Statistics Consumer Price Index for all urban consumers (CPI-U series): 1947 forward
For a more detailed discussion of Shiller's data, sources, approximations, shortcomings, etc. see chapter 1 of Irrational Exuberance, and the associated notes.  The early data is far from perfect.  On the other hand, it's the best information available.

Copyright © 2010. Last modified: 4/8/2012

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graph of 10-year T-Bond inflation-adjusted returns


  1. Thanks very much for posting your data sources. I was searching for some time for pre-1953 10-year bond yields.


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