Staff Working Paper No. 686: Eight centuries of the risk-free rate: bond market reversals from the Venetians to the ‘VaR shock’

This paper presents a new dataset for the annual risk-free rate in both nominal and real terms going back to the 13th century. On this basis, we establish for the first time a long-term comparative investigation of ‘bond bull markets’. It is shown that the global risk-free rate in July 2016 reached its lowest nominal level ever recorded. The current bond bull market in US Treasuries which originated in 1981 is currently the third longest on record, and the second most intense. The second part of this paper presents three case studies for the 20th century, to typify modern forms of bond market reversals. It is found that fundamental, inflation-led bond market reversals have inflicted the longest and most intense losses upon investors, as exemplified by the 1960s market in US Treasuries. However, central bank (mis-) communication has played a key role in the 1994 ‘Bond massacre’. The 2003 Japanese ‘VaR shock’ demonstrates how curve steepening dynamics can create positive externalities for the banking system in periods of monetary policy and financial uncertainty. The paper finally argues that the inflation dynamics underlying the 1965–70 bond market sell-off in US Treasuries could hold particular relevance for the current market environment.