Tuesday, December 11, 2007

Larry Kudlow on Real Interest Rates

October 4, 2001
Here's a TIP
It turns out that inflation-indexed TIPS are highly correlated with the stock market and the economy. Declining investment returns, sinking stocks, and falling economic growth are all captured in declining real TIPS yields. Ten-year TIPS, for example, have dropped to roughly 3% today from nearly 4.5% eighteen months ago.

As of today, we're looking at a mere 1.76%. Better hope the stock market and economy don't "highly correlate" soon.



Source Data:
FRB: Selected Interest Rates
Bloomberg: Rates & Bonds

2 comments:

MAB said...

Stag,

I hate to be a pest, but what yields are shown in this chart? Are they the stated TIP yields and if so is that supposed to indicate future inflation expectations?? Seems like a flight to safety rather than a realistic expectation for inflation.

I was on Vanguard's website and I compared their TIP fund to their total bond fund index and also their long term treasury index. All appear very closely corellated until late this year when TIPS suddenly outperformed.

Stagflationary Mark said...

MAB,

This is the real yield on the 10-year TIPS. TIPS pay a variable rate (the yield shown on the chart + the yield that comes from the TIPS rising with inflation).

It does not represent future inflation expectations, at least directly.

However, indirectly I would argue that it might. As real yields drop it should become more fashionable to hoard goods. At least that's how it works for me. Imagine how much I'd hoard if real (inflation adjusted) yields were seriously negative (as they were in the 1970s).

All appear very closely corellated until late this year when TIPS suddenly outperformed.

Real yields dropped off the side of the cliff (as can be seen in my "death of real yields" posts). Since TIPS are directly tied to real yields, TIPS therefore rose in price.

One way this can happen is if interest rates drop but inflation doesn't similarly drop. That's sort of what we've been seeing.

A cause could be that investors are having a harder time lately finding investments that will pay them real inflation adjusted yields elsewhere.