Inflation and real yields

18Jun07

Last week’s market theme was a focus on state and nature of inflation and the rise in real yields, that is the yield on bonds in excess of expected inflation. For some time now we have had the TIPs market to directly measure the market’s real yield and the level of expected future inflation.

Neil A. O’Hara in the New York Times has an article on the increasing attractiveness of TIPs. The yields on TIPs are now at levels not seen in a number of years. There are a number of nuances to investing in these securities, not least of which is the fact that they are keyed to the CPI.

James Hamilton at Econbrowser is surprised that real yields have risen so rapidly while implied future inflation has not. Absent housing, Hamilton believes a rising confidence in future economic activity is to blame. In another piece Hamilton looks back to see what a flatter than normal yield curve has meant for economic growth.

At Economist.com they examine reasons for the rise in bond yield aside from more rapid economic activity. They examine the desire for Asian central banks to continue accumulating U.S. treasuries and the steepening of the yield curve.

Bespoke Investment Group graphically depicts Fed policy against the performance of CPI. For the moment inflation remains above the Fed’s ‘comfort zone.’

Inflation matters. Not only in relation to real yields and the bond market, but to everyone. Given how inflation affects (literally) everyone in this country, it is shocking that there remains a great deal of debate over just how it should be measured. One thing is clear that few are particularly happy with the job the government is doing with CPI.

Barry Ritholtz at the Big Picture has been an early (and vocal) skeptic of how the BLS calculates the CPI. He looks at how the most recent CPI release can be looked at in two very different ways. In another piece he notes the consistent flood of bad news on commodity price front that seemingly does not make its way into the official statistics.

James Picerno at the Capital Spectator thinks an exclusive focus on the ‘core CPI’ is a mistake. He believes the top line CPI number has “consequences” for the real economy and should turn down before any one draws a sigh of relief.

Peter Coy at BusinessWeek.com examines the reasons why core CPI remained relatively quiescent, including the Fed’s refusal to cut rates earlier this year despite relatively weak economic numbers.

Jeff Miller at A Dash of Insight thinks the debate over the nuances of recent statistics are relatively unimportant. Rather the Fed’s interest is in containing inflation expectations as opposed to the monthly fluctuations of an imperfect statistic.

Frankly the debate over economic statistics makes our head hurt. What is important is how the market reacts. Real yields are higher. Nominal rates are higher. Some are now calling this a bear market in bonds. That would change the nature of the capital markets. Recent M&A activity has been driven in part by low nominal yields and tight credit spreads. A meaningful reversal in those variables could very have a dampening effect on the stock market. In the meantime keep an eye on the bond market. For now, it matters.

Advertisements


%d bloggers like this: