Government Bonds: Real Yield after Inflation

Buy when the yellow line is low, sell when it is high

Sample of chart showing correlation between bond prices and real yield after inflation (left scale inverted). Forecast year on year changes shown in orange.

This strategy shows how cheap or dear bonds are in real terms after allowing for inflation.

The bond market index is shown in as the thick white line on the right hand axis. The explanatory variable, real interest rate, the yellow line, uses the left hand axis. Best Guesses for future development of the valuation ratios are also shown on the left hand axis in orange. Best Guesses suggest what would happen to the valuation ratios based on Consensus Forecasts for bond yields.

For comparability, bond market indices have been rebased to set year-end 1994 at 100. Please note the differences between charts in the Bonds RouteMap and those for other RouteMaps. Since income is a major consideration for investment in bonds, bond market indices are shown as total return and not in terms of price only.

Owing to the conversion of legacy currencies into Euros, analysis is provided on a common bond market denominated in Euros, rather than for individual countries. Historical data is provided by creating synthetic GDP-weighted time-series for the component currencies, expressed in the European Currency Unit.

While this valuation ratio is important as the ultimate measure of value for long term bonds, it has fluctuated wildly in a very lagged response to inflation in previous years and recently also during flights to safety. Therefore it has been of little predictive use.