The real yield on intermediate-maturity government bonds in the Eurozone has moved beneath the minimum level reached in the US in 2012, ahead of a significant market sell-off.

The real yield is defined here as the average redemption yield on 7-10 year government bonds minus the consensus longer-term inflation forecast. The latter is sourced from the quarterly surveys of professional forecasters conducted by the Philadelphia Fed and ECB*.

Using month-end data, the US real yield reached a low of -1.2% in May 2012, ahead of the launch of QE3 in September. This reflected a nominal yield of 1.3% and expected longer-term inflation of 2.5%.

The Eurozone real yield is currently -1.3%, reflecting a nominal yield of 0.5% and a longer-term inflation forecast of 1.8%.

The US real yield returned to positive territory in July 2013 as the nominal yield rebounded, even though QE3 remained in full swing until December. 7-10 year Treasuries suffered a price reduction of 9.6% between May 2012 and December 2013, when the Fed announced its first “taper”. Including coupon income, the loss was 5.4%.

The view here is that the ECB has overreacted to a dubious deflation scare and monetary conditions are now excessively loose, evidenced by a surge in narrow money and rapid euro depreciation**. QE had limited economic impact in the US, UK and Japan but may prove more powerful and distortionary when combined with a negative interest rate on excess bank reserves. Eurozone bond investors may be running greater risks than their US counterparts in 2012.

*The forecast horizons in the Philadelphia Fed and ECB surveys are ten and five years respectively. The Eurozone yield is calculated by Datastream and covers 12 markets.
**M1 rose at a 14% annualised rate in the three months to January. The Bank of England’s euro trade-weighted index is down by 10% since end-December.