The market is making a big error. Companies and investors should take advantage of it. It is obvious but only few realise it, the FED included.
The yield on 10-year Treasury bonds has gone down in recent weeks. Despite one of the most aggressive rate hikes by the Federal Reserve raising the key lending rate by 0.25%, the benchmark Treasury has risen by only about 100 points this year. There are many different reasons for this odd trend and the current recession is only one of them. But it’s the situation with real yields that should really concern us. They’ve plunged and virtually nobody has picked this up.
After spending years in negative territory before going positive earlier this year, real yields (nominal yield minus inflation) are almost back at 0%. Despite immense pressure from the Federal Reserve, money remains very cheap and is even getting cheaper again. Consequence: when money is cheap, stock prices go up.
With real rates nearing negative territory again, money has no choice but to chase speculative action. That’s why stocks soared in July and real yields plunged.
But this is not the full story. The “real” real yield is much, much lower than anticipated. In the “official” calculations of real yields the inflation figure used is 2.8%, just a fraction of today’s inflation rate. In my opinion, this is much to low because it represents the market’s expected rate of price increases over the next 10 years will be back to normal very soon. I believe this is a much too optimistic vote of confidence for the Federal Reserve and its action that is far behind the curve.
So, if inflation is at 9% now, how are we getting to an average of under 3% in the next years? I can not see this happen.
The inflation number being used to calculate real yields is way too small. We should rather subtract 4-5% from today’s nominal 10-year yield to calculate the true return we’d see on our money. If that’s the case, real yields are actually far lower than they were at the height of the speculative bull market.
But what is the Fed going to do about it? The central bank is in a real dilemma. If the Fed wants to stop it, rates have to go much higher than anticipated. And we know what that means for the stock market.
Sven Franssen