Thursday, January 31, 2008

The Death of Real Yields Continues

On January 10th I thanked the stock market bulls for giving me what looked like a dead cat bounce in the 10-Year TIPS yield. Using hindsight, that thank you appears well founded. I was buyer in the TIPS auction that day. I got a pretty good yield, all things considered (see the spike in the chart below).

In sharp contrast, those hoping for higher real yields while parked in cash found no relief in today's action. The death of real yields momentum appears to be "well anchored" even during today's impressive stock market rally (money also flooded into my TIP bond fund at double normal volume). In theory, a 0% real yield is the lowest it can possibly go (since TIPS cannot yield less than 0% during an auction). Things would get really interesting at that point (and when I say interesting, I actually mean depressing).

I find it very hard to imagine anyone (other than me perhaps) would accept such a low real yield willingly. However, those who have studied the 1970s would see that real yields can turn negative on treasuries of all durations thanks to persistent and rising inflation. I can't say for sure that's what we'll be getting, but I see very little reason to rest assured we won't. Just look at the yields on the short-term treasuries. Those real yields appear to be negative. In my opinion, it is the logical conclusion of seeing way too much money (in the hands of the rich but certainly not of the poor) chase far too few investment ideas now that the you know what and the fan are meeting up.

I've been stagflationary (using falling real yields as my definition) since 2004 and I see very little reason to change my long-term mood. Apparently it is going to take more than a popping housing bubble and a credit crisis to offer disinflationary relief, thanks to Helicopter Ben making the rounds.

If I had but one prediction, it would be that it will grow increasingly difficult to make money off of money going forward. That's why I continue to track what I call the death of real yields. Does that mean I'm endorsing backing up the truck on gold and silver? Not really (although heaven help us if we all should be in gold and silver at these prices). They've had quite a run. Surely there must be something of better value these days, like toilet paper (which is still cheap if inflation truly is coming). I'm especially fond of I-Bonds. They are SO much better than TIPS these days. They have a 1.2% real yield that's tax deferred for up to 30 years. In fact, they are such a good deal in this environment that the government just dramatically reduced the maximum you can buy each year. Should that interest you, you have until the end of April to get that 1.2% real yield. It will then be reset (presumably lower based on what real yields have been doing).

Maybe I'm wrong. Maybe real yields will shoot higher as inflation picks up and Bernanke raises rates to counter it. That's always a possibility. It just doesn't seem like a very likely possibility these days. Emergency rate cut meetings combined with nearly desperate pleas for a stimulus package implies inflation is the last thing on his list of worries at the present time. It is also possible I'm wrong about future inflation. Maybe the USA will be flooded with even cheaper goods from overseas even as our dollar falls and billions strive for our standard of living. Forgive me for not holding my breath on that deflationary outcome.

This is not investment advice. It is just the opinion of a random anonymous bearish blogger on the Internet. Keep that in mind.

Source Data:
U.S. Treasury Real Yield Curve Rates


MAB said...


Today on the Bloomberg web site, I noticed the five year TIP had a 0.49% (get) real yield. I'd say that's extreme and shows a whole lot of justified fear. That fear doesn't square with the "faith in the fed" that wall street trumpets imo.

Anyway, as expected, wall street has turned this current state of fear into yet another "compelling" sales pitch. I keep seeing nitwits on tv proclaiming that 3.5%10 year yields prove that stocks are undervalued. No mention that 10 year yields were well over 5% a mere 6 months ago or that inflation is increasing. All the while the financial media smiles and cheers.

Some day it would not surprise me if the financial industry ends up in a decade long class action suit from states similar to the tobacco industry. Hey, now there is an idea!

Stagflationary Mark said...


It is similar to 2004 when it comes to real yields. On 3/17/04 the five year TIPS yielded just 0.39% (the low point).

We're reflating again, but this time it doesn't appear that we're trying to turn deflation into inflation, but more like inflation into even more inflation (at least long-term).

Trivia: That 0.49% real yield on the five year TIPS is within 0.49% of the odds of me locking in the current ~2.7% interest rate on the 5-Year non-inflation protected nominal treasury! One might say I'm zero bound!

I can't say the 10-Year TIPS was any bargain, but the rate at the auction was ~1.6% over reported inflation. The rate is now down to just ~1.3%. That's 0.3% in three weeks. That amounts to about a 3% gain (0.3% per year times ~10 years).

I also can't say that the 20-Year TIPS is any great bargain either, but the 1.8% rate I got just two weeks ago beats the 1.7% rate its at now. That's 0.1% in just two weeks. That amounts to about a 2% gain (0.1% per year times ~20 years).

Hindsight continues to be kind to me. Foresight doesn't though, since the more real yields drop now, the more difficult it will be to make money off of money in the future.

Got socks?

MAB said...


I just can't understand why there is no outrage over 4.1% yoy inflation. If inflation expectations become unmoored, there will be hell to pay. Stocks and bonds will get re-priced downward, perhaps drastically.

Here is the reality for the ordinary interest bearing part of my portfolio from 2007.

$10,000*5.10% = $510 gain

Taxes (city,state & federal = 40%):

$510*40% = $204 = $306 after tax gain.

2007 year end balance: $10,306

Adjusted purchasing power with 4.1% inflation:
$10,000*4.1% = $10,410

2007 y/e purchasing power:
$10,306-$10,410 = -$104 (1% loss)

Without question, I would be better off with zero interest and zero inflation. Cleary, my 2007experience argues strongly for hoarding.

Where are we in 2008? The interest rate I receive has dropped 25% and is plunging lower. My morning coffee at Dunkin Donuts just increased 6.6%. I asked the coffee servers if they had just receive raises. They laughed and said NO! Gas remains at $3.00/gal and oil is still at $90/bbl.

I don't see the wisdom in sacrificing stable prices in an attempt to re-flate greedy and foolish banks and fickle asset prices. My daily costs are real, the asset prices are an illusion. Inflation will eventually change social mood and Bernanke will have to fight a war on two fronts.

Bernanke is playing with fire.

MAB said...


Trivia: That 0.49% real yield on the five year TIPS is within 0.49% of the odds of me locking in the current ~2.7% interest rate on the 5-Year non-inflation protected nominal treasury! One might say I'm zero bound!

My previous comment on 2007 after tax purchasing power demonstrates that I did not even achieve a zero bound status.

Got socks?

Yes, I have plenty of socks. And they were more productive as a store of value than my savings account in 2007.

The problem I see is that everybody has plenty of "stuff." Every closet and garage in America is packed full. And the garages and closets are bigger and more numerous than ever. Heck, millions even see the need to rent additional "self" storage space.

Contrary to the hopes of our government and the fed, going forward, I think Americans will start to save more and consume at a slower pace. A Keynseian governmental response will surely follow.

Stagflationary Mark said...


Where are we in 2008? The interest rate I receive has dropped 25% and is plunging lower.

I agree. There's a dollar glut (too many dollars chasing fixed investments drives interest rates down).

The problem I see is that everybody has plenty of "stuff."

I agree. There's a "stuff" glut.

The inflation vs. deflation debate continues on!

There is no rule that says there must be a safe place to invest when the "inflation tapeworm" (to quote Warren Buffett) is unleashed. And when I say inflation tapeworm, I really mean a lack of real yields environment (inflation greater than "safe" interest rates).