Quantifying the impact of risk and growth factors on Treasury yields
Are yields rising because of strong growth or because there is less risk?
Are Treasury yields rising because growth is stronger, or because the world has less risk and safe-haven demand is falling? The correct answer is all of the above, and a simple regression analysis helps to quantify the respective impact of the “risk” and “growth” factors.
During the past six months we observe a familiar relationship between gold and 10-year TIPS yields. Gold and inflation-protected securities both act like deep out-of-the-money put on the dollar and typically trade together.
Something else is affecting TIPS yields besides systemic risk. We see a clear trend in the residuals of the regression of 10-year TIPS yields against gold:
By adding a trend variable to the regression, we obtain a much better fit (nearly 90% as opposed to less than 60%).
All variables retain sign and significance after correction for serial correlation.
We can view the trend variable as a growth effect. It’s consistent with stronger data across the board.
Multiplying the regression coefficient by the value for gold and the trend, respectively, gives us the respective impact of the growth trend and the risk factor proxied by gold.
The growth trend accounts for 10 basis points of increase in the TIPS yield during the April-October period:
Over the same period, the net impact of gold is almost neutral. But changes in the gold prices corresponded to 25 basis points of peak-to-trough variation in the TIPS yield.