Monday, February 7, 2011

Real Yields

The following chart shows how you would have done buying a 1-year treasury in the given year and holding it until maturity.

The following chart shows how you would have done buying a 10-year treasury in the given year and holding it until maturity. The return shown is per year. Yes, it is possible to lose 2% per year for 10 straight years.

I've been predicting the death of real yields for many years. Note the red trend lines and how low they ended up in the 1970s. Gold and silver prices are confirming the concern here.

These charts explain why I am looking forward to the 30-Year TIPS auction this month. I'm more than happy to lock in a real yield of over 2% long-term. I'll be using the proceeds from a 2.38% 5-Year TIPS note that I bought in 2006 to fund it.

I offer a special thanks to the current round of stock market bulls for getting out of my way. The timing is fantastic. The
auction should be announced this Thursday.

As a side note, I doubt very much that hindsight will show that today's 10-year nominal treasury bond yielding a fixed 3.68% will yield a high real return once inflation is factored in. Anyone planning on that outcome might wish to rethink their assumptions. I'm talking specifically to you pension funds. That doesn't necessarily mean that 10-year nominal treasuries offer no value. It will all depend on what inflation does (or doesn't do). We won't know for sure until 2021 of course.

Source Data:
FRB: Selected Interest Rates
St. Louis Fed: CPI-U


Stagflationary Mark said...

I should point out something about that second chart.

That red trend line has had 10 years to fall since we've last seen a data point. For example, I cannot know for sure how the 10-year treasuries bought in 2005 will do until 2015.

I can make a guess though.

The 10-year was about 4.2% back then.

There's been 6 years of inflation averaging about 2.3%. That would put the real yield at about 1.9% if the trend continues.

So much for 4% real yields. We need to get over it and adapt to the new reality.

Stagflationary Mark said...

One more thought.

Nothing spells out the new reality like 0.0% I-Bonds.

They've hit the floor and are desperately trying to claw their way through.

That's assuming we can assign human emotions to a bond of course, lol. Sigh.

nanute said...

Have you looked at this?
If I'm reading this right, it would appear that the expected rate of inflation over the next 10 years is 2% on average?

Stagflationary Mark said...


I've read that commentary and I've done similar charts on my blog.

Here's my take on the methodology. I think it is somewhat flawed.

Broken Inflation Expectations?

Since hard goods have been skyrocketing in price, I therefore submit that inflation expectations are higher than TIPS would suggest. Heck, for all we know some TIPS holders are actually defecting in this game. Let's say you own TIPS and your inflation expectations rise considerably. Do you buy more TIPS or do you sell what you have and start hoarding hard goods in earnest? If you do the latter you will actually be forcing DOWN the derived TIPS/treasury inflation expectations that Bernanke likes to follow. As you are off hoarding hard goods instead, Bernanke will see inflation expectations even more contained. Now that's a conundrum!

In hindsight, deflation struck with a vengeance later that year. Inflation expectations changed dramatically.

Even if one could accurately say what inflation expectations are for the next 20 years, that does not mean they are an accurate prediction of the future.

For example, we could poll people to determine what the stock market will do over the next 20 years. We'd get an accurate estimate of what the consensus thinks it would do. What it actually does is another matter entirely though.

nanute said...

I looked at your post, and it seems your projections are about the same, more or less, no? It would seem that with current talk at the Congressional level, cuts in spending will most likely offset any targeted inflation levels the Fed is trying to achieve. To borrow a phrase from John Fogerty: "I See A Bad Moon Arising." Go long on the 30 yr TIP.

Stagflationary Mark said...


My 30-year inflation expectations are not well grounded. It's somewhere between Japan's 0% and 1970's 8%. My best guess would probably be 3%, assuming we run below that for a few years and eventually start to run above it.

Jazzbumpa said...

I think people's inflation expectations are -- inflated.

Here is a long range look. Inflation volatility in the last decade has not deflected the long range trend - now approaching zero.

I don't think secular trends change without a major (or even catastrophic) event. Inflation blew off in the early 80's and has been slumping since.

What could happen now to cause a reversal? All you hear, all over the world is austerity. I seriously fear a major deflationary event (i.e. GD II) before there is major inflation again.