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Real Yields Are A Real Problem

By Ashraf LaidiMarket OverviewNov 11, 2021 12:18AM ET
Real Yields Are A Real Problem
By Ashraf Laidi   |  Nov 11, 2021 12:18AM ET
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by Adam Button

One of the great puzzles in markets at the moment is the ongoing drop in inflation-adjusted bond yields and how it points to trouble ahead. The trade has the potential to blow up and reverberate through markets. On Tuesday, the WhatsApp Broadcast Group had a few "quick" day trading trades in XAU/USD (long at 1821 for 1830), DOW30 (long/short inside 36170/230), and DAX 40 (15990-16050).

The theme in the FX market continues to be yield-spread compression as central banks push back on inflationary concerns. What's concerning is that US real yields in 10s and 30s are at all-time lows. In 30s, TIPS hit a record low of 0.578% on Tuesday while nominals trade at 1.82%. That difference reflects average inflation of 2.4% over that timeline and signals that owning either asset will result in a substantially negative real return.

It also makes a compelling argument that the bond market is the greatest bubble in human history with $22.1 trillion in Treasuries outstanding and an order of magnitude globally priced against it.

If inflation were to normalize at 2.4% it should prompt a Fed normalization over time, crunching long-dated bonds and quickly threatening to invert the yield curve. That's something that would imply lower inflation and boost real yields. Alternatively, long-end nominal rates could push higher on sustained high inflation and crush outright bond longs.

That's something to ponder over the longer term but in the days ahead, volatility in the bond market remains elevated and that's something that could spill over. The calm and enthusiasm in the equity market is masking deep issues in bonds. As usual, bonds will win out.

There were no clues in Tuesday's PPI report, which was largely in line. The CPI data was expected up 5.3% y/y, a slowing from 5.4% in September. Core m/m inflation was expected at 0.3%.

Real Yields Are A Real Problem

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Real Yields Are A Real Problem

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