Where are the ‘Negative Real Rates’ ?

By: Uri Estrin - August 11, 2020 09:50am EST
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0.6% CPI - in normal times that would be rather tepid  - and especially after $7T of extraordinary stimulus
0.6% CPI - in normal times that would be rather tepid - and especially after $7T of extraordinary stimulus

There is a lot of chatter about Negative Real Rates and how they are pushing investment strategies. Most of this chatter is coming from Gold Bugs to substantiate their call for stratospheric prices.

First – let’s define what Negative Real Rates are exactly. Real Rates are the difference between interest rates and inflation. If interest rates are say at 5% and inflation is running at 2%, the net, 3% is the real rate. Negative Real Rates are when rates are lower than inflation, in other words, the real return is negative. So for example, rates are 2% and inflation is 3%, the real rate is -1%. (Here is some additional reading and the fisher formula for calculating real rates: https://en.wikipedia.org/wiki/Real_interest_rate#:~:text=Negative%20real%20interest%20rates,-The%20real%20interest&text=If%20there%20is%20a%20negative,every%20dollar%20borrowed%20per%20year. )

Rates are historically low– the 10yr Treasury Yield is at 0.642% currently – which indeed is a very low return. 30Yr yield currently is hovering around 1.32 and Federal Funds Rate (which is used to calculate real rates) is at paltry 0.25%

The Fed has stated, it’s their objective to keep rates very low, for a very long time. So the other variable in this equation is inflation.

TIPS are taking off – these are Treasury Inflation Protected Securities. They are Treasury Securities that adjust with inflation. TIPS are currently hot items – and there is a speculative rush into them side by side with the Gold Bugs.

But such predictions of inflation are in its early days. Even if inflation does present itself – we at MacroTOMI are extremely sceptical about an inflationary shift (read our article: No Inflation, No Stagflation, Yields and Bonds), and it would be muted and short lived, cyclically it’s not the right time for real robust inflation taking hold – the kind these guys are salivating over – the inflationary elements just aren’t present.

June 2020’s CPI print was at 0.6%. This is higher than the Federal Funds Rate and technically, real rates are negative. Here’s the thing though – context. Seasonally adjusted CPI for March, April and May 2020 were -0.4%, -0.8% and -0.1% respectively. So taken in context, there is a small spike of 0.6% after 3 months of negative readings – probably consistent with the ‘pent-up demand’ post lock down. But this doesn’t indicate a clear pattern, nor is it a big jump – it’s 0.6% - in normal times that would be rather tepid (and a far cry from the Fed’s goal of 2% - and especially after $7T of extraordinary stimulus coupled with the biggest forbearance and moratorium program ever seen. If we were in a real inflationary environment – this number should be spiking above 4%, 5% or even higher. 0.6% doesn’t justify a cry for inflation or Gold or TIPS – in a reading that is notoriously know for its fluctuations.

Today, July’s PPI reading was 0.6% after last month’s decline but there are muted cost pressures in a struggling economy. Tomorrow we see July’s CPI reading. July’s reading is already forecast to not be very high– further dampening the inflation mongers. If we’re entering a period of high and prolonged inflation, why isn’t the yield on the 30yr Treasury spiking too ?

When there is a rapid interest and acceleration of a single commodity or instrument without other signals working in tandem – it makes me fearful. I’m also fearful of the greed – so should you be.


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