What were factors that led to a decline in bond yields during World War II given that the opposite should have happened?
score:8
Bond yields dropped as it became more and more apparent that the United States would win the war. Then the war expenditures were seen an "investment" in a lasting and durable peace. At the end of World War II, the U.S. had 50% of the world's industrial capacity, up from 40% before the war (according to Paul Kennedy in "The Rise and Fall of the Great Powers).
The great fear was NOT that the borrowings were "too high" and could not be repaid. It was that the Axis would win and not honor the U.S. issued bonds.
Or, more likely, they might "draw" and start a Cold War that would keep bond yields high. Bond yields did, in fact rise through the 1950s (and later), as a result of the Cold War against the Soviet Union. That was a factor in the multi-decade bear market in bonds that lasted until the early 1980s.
One reason for the spike in interest rates in 1980 was the Iranian hostage crisis. Basically, an attack on the 52 American diplomats was an attack on U.S. world power and leadership, leading to a rise in yields.
Geopolitical factors sometimes "trump" economic ones.
Upvote:4
The return on a bond can, to a first approximation, be thought of as the inverse of it's price. When bond yields drop this means their price rose - due to either decreased supply or increased demand. In the Forties the U.S. economy started to recover from the Great Depression; people got jobs again, and the demand for some place to keep the earned savings safe grew; so bond demand rose; and the price went up reflected in decreased rates.
In the cold war inflation started, first slowly and then more rapidly through the early 1980's (when mortgage rate in North America topped out at 20% per annum). This increase in inflation must be compensated by a lower price for a long-term investment such as bonds, reflected in continual increase in rates.
Then as inflation rates started dropping again the demand for bonds again rose, increasing demand and increasing prices, reflected in dropping rates.
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