The US yield curve is currently at its flattest level for more than ten years, with ten-year Treasuries yielding just about 60 basis points more than two-year bonds. At the start of 2017, the difference was around 130 basis points. You can also see that the German Bund curve is currently about twice as steep as the US Treasury curve and has remained relatively stable, with ten-year bonds over most of the time yielding around 100 basis points more than two-year bonds – not very far from the average observed over the past 20 years. My second slide focuses on the US Treasury curve. What you can see here is the ten-year yield 1/7  BIS central bankers' speeches  and a model-based breakdown of the yield into its two main components: the average of the current and expected future short-term interest rates over the maturity of the bond and the term premium. All series are shown as cumulative changes since the start of last year. Two facts can be drawn from this chart. The first is that the recent marked flattening of the curve reflects what markets call a “bear flattening” – that is, short-term rates have been rising faster than long-term rates. This is evident from the fact that the ten-year yield – the blue solid line – today is about the same as it was a year ago. Short-term interest rates, meanwhile, have risen by around 90 basis points.
And within that asset class, most market participants have rebalanced their portfolios towards US Treasuries and government agency bonds. This confirms that the portfolio rebalancing channel has been instrumental in delivering the intended benefits of our quantitative easing. Slide 4 shows the extent of this rebalancing more clearly. Since the start of our asset purchase programme (APP), euro area investors alone accounted for more than half of foreign purchases of US debt securities. History suggests that these shares are highly unusual for the euro area. Only recently has the share started to decline again. Now, according to conventional models of the term structure, such capital flows should play no direct role in determining yields.4 In these models, the term premium reflects the covariance between expected bond returns and the representative investor’s stochastic discount factor. However, the conditions under which the supply of and demand for bonds are entirely neutral on yields are very restrictive and unlikely to hold in practice. Indeed, it is now widely accepted that arbitrageurs are often risk-averse and that many investors have so-called preferred habitats for certain assets or segments of the yield curve.5 Pension funds, for example, typically need to invest a significant portion of their assets in safe long-dated bonds to match the liability side of their balance sheet. With arbitrageurs capital-constrained, changes in the demand from preferred habitat investors can then affect the price of duration risk and hence term premia.