EDITOR'S NOTE
One thing has been bugging me since I wrote this piece last week about being at a major inflection point as it pertains to the dollar, rates, and asset prices.
Why are real rates so low right now, and why would they stay that way?
The "why," it would seem, is that the market is still extremely skittish and risk-averse in the wake of Covid. "Right now, with these levels in real yields, the market is willing to give a dollar to the government today just to ensure that it can get a risk-free inflation-adjusted 90 cents back 10 years later," Jefferies' Dave Zervos wrote on Friday.
(Real rates have continued to slide, to -1.1% as of this morning based on the 10-year TIPS yield, so now you wouldn't even get that much back.)
It's odd to me that risk aversion would be more severe today than in the depths of the crisis, but FHN's Jim Vogel has a helpful explanation. The March/April period was a scramble to raise cash and avoid portfolio destruction; real yields actually spiked as people dumped TIPS (see below). In April and May, after unprecedented Fed intervention, investors focused on gobbling up corporate bonds instead, he said, "to preserve interest income through an extended period of low rates." (Sure enough, Google's bond deal this week had five-year debt offering just 0.45%--a record low.) Only after that point did banks and other investors start buying Treasurys and TIPS "by the bucket," especially as the spread of Covid worsened.
"In effect," says Mr. Vogel, "the current market is a delayed reaction to a series of events over the past five months." He also thinks the buying in TIPS is causing real rates to decouple somewhat from fundamentals--and to the extent that inflation fears cause more investors to pile in, real rates will keep sinking unless Treasury yields start to rebound.
Morgan Stanley's Jim Caron also emphasizes that the yield on TIPS keeps dropping because of the weakening dollar. "If the value of the [dollar] falls, people move toward [real] assets to store value, like gold and silver," he wrote last week. TIPS are also a "store of value," since they have inflation protection built in. Hence their price keeps rising, and the yield keeps dropping.
And that's likely to continue, says Mr. Caron, so long as fiscal policy is easing along with monetary policy. "There is no free lunch," he wrote. "The [dollar] bears the burden, and loses value."
And that is how you come back to the same conclusion I wrote about last week--that this setup argues for a weaker dollar and higher asset prices, stocks and bonds included. This is not (yet) an inflation-is-coming paradigm, which would cause a major selloff in the bond market and be a huge headwind for stocks.
See you at 1 p.m!
Kelly
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Kamis, 06 Agustus 2020
Real rates and real inflation
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