What’s a Real Yield Anyway?

What is a Real Yield Anyway

In last month’s newsletter we suggested that while market focus was on a flat yield curve on its way to inverting, we were more concerned with the long end of the curve following more than a decade of “quantitative easing”, meaning Federal Reserve manipulation of the long end yields. As the Fed is allowing the sunsetting of its asset purchase program it has allowed long term rates to increase in tandem with short, so that in the last month the curve has remained flat, yet it’s is about 1/3 of a percentage point higher both at the 5 year level as well as the 10 and 30 year levels.

The US 10 year yield is now touching 3%, and 30 year mortgages approaching 5.5%. This shifting of yields higher across the maturity spectrum as well as across risk assets has had real world implications with 30-year mortgage rates about 1% higher in the last 30 days. Were this trend to continue, housing affordability will deteriorate, risking a housing correction, despite a decade of underinvestment in housing. Were first quarter GDP growth, a somewhat anomalous negative 1.6%, to be followed by a negative second quarter as well, we would already be in a recession (a recession is defined as two consecutive quarters of negative GDP), something that most economists don’t believe will occur until 2023.

The increasing US yields, especially relative to other countries’ yields, is pushing up the dollar to levels not seen in decades (EUR under 1.06, Yen up to around 130 for example). Hot inflation numbers are raising prices across the board and throughout the economy, a leftover of Covid-related fiscal measures that have led to a combination of supply chain imbalances with ample “free money” which has driven up demand.

Depending which inflation gauges one uses, real interest rates (nominal interest rates minus inflation), have started to turn positive, for the first time since the 2008 Financial Crisis. By some measures real interest rates peaked in 2018, the only negative stock market return year since then. We are bracing for a challenging year ahead in asset prices, as we expect inflation to remain an issue while at the same time the sunsetting of the Fed’s asset purchase program allows yield to continue to find their market-based footing.