US Rates: Real or Expectations?
There is a general understanding of what happened last week. The 2.9% rise in average hourly earnings in the US reported, the fastest since 2009 spurred fears of rising inflation. The jump in US interest rates triggered equity sales and a spike in volatility, which in turn spurred the unwinding of low vol bets that had been paying off handsomely....MORE
While this consensus narrative has much to recommend itself, there is a major discrepancy. The rise in US interest rates since both the end last year and since the January employment data appear to reflect mostly an increase in real rates and not the inflation premium.
This preliminary assessment is borne out by reviewing the change in nominal yields and the change in market-based measures of inflation expectations. The US nominal 10-year yield finished at 2.79% the day before the latest employment data were released. The yield finished last year a little above 2.40%. The high yield print has been almost 2.90%--a 50 bp increase from the end of last year and a 11 bp since before the employment data.
There are two readily available market-based measures of inflation expectations. There is the 10-year breakeven, which is the difference between the 10-year conventional yield and the 10-year inflation protected security (TIPS). The 10-year breakeven was at 1.98% at the end of last year and 2.12% before jobs report. It reached 2.14% last week, and is now near 2.08%.
Another market-based measure of inflation expectations is the five-year five-year forward breakeven, which is similar to the 10-year breakeven, but uses a five-year forward rate of the conventional and inflation-linked securities. A similar picture arises. The five-year five-year forward was at 1.99% at the end of 2017. It was at 2.22% before the jobs data and now is near 2.21%.
Most of the rise in nominal yields took place before the average hourly earnings surged. However, the increase in these two market-based measures of inflation expectations do not explain the bulk of the increase. Both measures of inflation expectations are now actually unchanged or lower than prevailed the day before the data were reported while nominal yields are higher.
There are other reasons to doubt that inflation expectations became unanchored by the average hourly earnings data....
And from Dan McCrum at FT Alphaville, Feb. 13:
Tantrum comparisons charted
In the attempt to rationalise explain what just happened to markets, Deutsche Bank have gone back through the archive for moments when the possibility of higher interest rates spooked investors.
It doesn't take long, as there are only two episodes in the last 30 years: the Alan Greenspan surprise in 1994, and the Taper Tantrum of 2013.
In the first, the Federal Reserve unleashed a 50 basis point hike, and went on to push up rates by 2.5 percentage points in a year. In the second, Ben Bernanke talked about the possibility of tapering and caused bond markets to freak out, a little.
Fixed income markets are not so bothered, yet:
Stock markets, however, have been a little more fractious.......MORE
