Real Yields are a Real Problem
The yen was the top performer on Monday while the Australian dollar lagged. 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 reflect 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.
Should inflation 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.
A potential breaking point is only hours ahead with October CPI due at 1330 GMT. There were no clues in Tuesday's PPI report, which was largely in line. The CPI data is expected up 5.3% y/y, a slowing from 5.4% in September. Core m/m inflation is expected at 0.3%.
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