Definitely, and within a very few days, the fear of spread + interest rates blaze BTP back in Italy, fomented by the fear – as in the rest of the world – of more or less imminent rate hikes by central banks in difficulty in managing inflation, she returned.
In the last few sessions, the yields of 10-year BTPs fell to the lowest value of the last 26 days, or 0.83% (from 1.21% post ECB), while the rates of 30-year BTPs fell to at the lowest value since last September 23, to 1.72% from 1.91% at the beginning of the month.
Compared to the peak of 131 basis points in early November, the BTP-Bund spread fell back to area 116.
Everything okay, then? Have the markets decided to give credit to the ECB? Not at all, indeed, one could answer with the phrase “on the contrary”.
On the inflation-ECB issue, it is very useful @AlienoGentile’s Thread.
The focus is shifting to dynamics of real rates of government bonds from all over the world, which in many cases collapsed to the minimum values ever, from the euro area to the United States, up to Australia. What’s going on?
What is happening is that the fear of inflation is now being felt all over the world, and that professional and non-professional investors have launched a tight hunt for anti-inflation solutions.
Whether it is the classic gold, or Bitcoin and Ethereum, considered by many to be a new entry in the sector of hedge instruments against the flare-up of inflationary pressures, the fever is for everything that can protect against the devaluation of one’s purchasing power. Government bonds that protect against inflation, such as US TIPS, are therefore welcome.
The message, clear and strong, comes from trend of real rates.
It is worth mentioning that real interest rate = nominal interest rate – inflation. The higher inflation is, therefore, the lower the real interest rate is.
To explain its importance it is the ECB itself, on its website:
“For those who take a loan or deposit his savings it is not only the nominal amount paid that counts; it also matters what he can buy with that money. Economists call it the ‘purchasing power of money’. It usually decreases over time as prices rise due to inflation. If we take inflation into account, we really understand how much a loan costs us and how much savings make us ”.
The central bank also presents a practical example:
“A saver who deposits € 1,000 into an account for one year can benefit from a nominal interest rate of 2.5% and thus get € 1,025 after one year. However, if prices rise by 3%, he will have to pay € 1,030 to purchase the same goods and services that would have cost € 1,000 a year earlier. Means that the real yield it will have actually been -0.5%. This is the real interest rate, which is calculated by subtracting the inflation rate (3%) from the nominal interest rate (2.5%) ”.
Real rates alert: down to historic lows, world scared of inflation
Having made this distinction between the nominal rate and the real rate, we come to what is happening in the world:
real bond rates are increasingly capitulating, as Bloomberg points out in the article Bond Market Flashes Mixed Messages as Real Yields Sink Deeper, which indicates how the decline in yields is confirming an increasingly widespread and global phenomenon.
Let’s start with what is happening in the United States, where, with inflation expectations rising and nominal rates falling, so-called real yields on US government bonds have slipped even further below zero this week.
Particularly, the 30-year TIPS rate – that is the securities that protect against inflation with a thirty-year maturity, yesterday fell to a record low, around -0.60%. Such a decline, explains the Bloomberg article, would normally suggest that the bond market has a deeply pessimistic view on economic growth, which is therefore anticipating a slowdown that would keep rates low over the next few years.
The problem is that the movements that are taking place in the largest bond market in the world, the American one, are openly challenging the above explanation, given that the US economy is emerging. from the worst economic effects of the Covid-19 pandemic.
Not for nothing, some strategists point out that the decline in real rates also reflects other factors, including the repositioning of portfolios by traders and the fear that a high rate of inflation will become rooted in the economy (other than transitory, as they say is Jerome Powell’s Fed and Christine Lagarde’s ECB).
“The point is, if you believe real rates are attractive right now, that means you believe longer-term inflation will remain quite high for a considerable time frame,” Jerome Schneider, head of division, told Bloomberg. of short-term portfolio management at Pimco.
However, Schneider does not see it that way: in his opinion the facts will prove the Fed right in the end.
“Real rates will return to being less negative as inflation returns to the area considered more acceptable by the Fed.” Sara.
The point is that the bond market, Bloomberg points out, prizes a higher, not lower, inflation risk.
Ten-year TIPS rates, for example, dropped to -1.2%. The consequence was the widening of the gap between these rates and the 10-year Treasury rates: this differential, a parameter of inflation expectations known as the break-even rate, thus increased from around 2% at the beginning of January to 2.64%.
Furthermore, the significance of the incidence of these TIPS is worrying which, according to another Reuters article, would confirm that the concern of higher inflation is spreading more and more in the public and among retail investors.
“The inflation numbers we are receiving every month are no longer a phenomenon that only interests investment professionals, but also the massKevin Flanagan, head of WisdomTree’s fixed income strategy division, told Reuters.
At the same time, Flanagan pointed out that, the fact that conventional debt (government bonds unprotected from the threat of inflation) holds up – and also very well – confirms that there are also investors who are starting to believe. in the Fed’s transitional inflation narrative, or at least in the ability of Jerome Powell and others to limit the flare-ups in price growth.
And indeed 10-year Treasury yields fell yesterday to 1.4341%, while those thirty years have dropped up to 1,795%, at the lowest value since July. The yields of 10-year BTPs also fell, which yesterday capitulated down to the lowest value of the last 26 days, equal to 0.83% (from 1.21% on 1 November), while the rates of 30-year BTPs they fell to the lowest value since 23 September, to 1.72% from 1.91% at the beginning of the month. Compared to the peak of 131 basis points at the beginning of November, the BTP-Bund spread fell back to area 116. At current values, considering the ten-year rates, and subtracting the inflation rate in Italy equal to 2.9%, the real ten-year rate in Italy is around -2.07%.
The case of Italy, more than for inflation, here the fear is for the recovery
As for the case closest to us in Italy, the tweet of a few days ago is indicative Philipp Heimberger @heimbergecon , economist at the Vienna Institute for International Economic Studies (@wiiw_ac_at):
“In Italy, inflation – wrote the economist on Twitter – is around 3%, but core inflation remains low, at less than 1% (excluding energy prices which are volatile in themselves) and ‘inflation it is not fueled by rising wages. Wage growth remains slow. Therefore, there are no good reasons to worry about inflation in Italy, while there are excellent reasons to worry about the recovery of its economy ”.
Said this, the fear of inflation has been high for some time, also for cultural reasons, in Germany.
Here rates of inflation-protected 10-year bonds, which reflect so-called real yields, have fallen in the last few hours to record low of -2.09%.
On the other hand, the prospect that the ECB will not raise rates for a long time has led 10-year Bund rates to drop to a minimum since September 23, to -0.287%, while 30-year Bund rates are specifications at the lowest value since the end of August.
On negative real rates Subadra Rajappa, head of the US rate strategy division at Société Générale, explained that the reductions are becoming more and more widespread. The expert cites the case of the UK, where real 10-year gilt government bond rates are precipitated to record low of -3.26%; and Australia’s 10-year real rates, which fell to -0.4% after turning positive at the end of October.
Antoine Bouvet, senior rates strategist at ING, motivated the yield trend with the dovish attitude of central banks, which – Bank of England inclusa, despite expectations of a rate hike in the last meeting at the beginning of November – drowned out expectations of imminent monetary tightening.
The result is that, not convinced, several investors have increased the demand for “hedge instruments against inflation“.
In short, the markets are continuing to disavow central banks, as has been evident, moreover, in the case of ECB of Lagarde.
Bouvet added: “The question is not whether the fear of inflation will be endorsed or not. In the short term, investors have no doubts that inflation is rising ”.