Don’t Forget About The Plague

“10-year US real rates are now -4.6%,” BofA’s Michael Hartnett wrote, in the latest installment of the bank’s popular weekly “Flow Show” series.

Over the past two centuries, such extremes “have been associated with panics, inflations, wars and depression,” he added, referencing the annotated figure (below).

Maybe it’s just me, but sometimes it feels like the cadence we employ while highlighting various market and economic anomalies suggests we’ve forgotten what just happened to the world.

If instances of deeply negative real rates have generally coincided with “panics, inflations, wars and depression” then it makes complete sense why real rates should be deeply negative right now. After all, we had a panic and a depression last year. This year, we have inflation.

As far as war goes, we’ve been trying to have one with China for the past half decade, but it keeps getting delayed. Officials from both countries are still working to hammer out the details. The public will be notified once an agreement is reached on mutually assured destruction.

Macabre humor aside, I’d gently suggest that even if you’re inclined to place the blame for today’s inflation and a decade of worsening inequality on bad policy (monetary policy post-financial crisis and the monetary-fiscal nexus post-COVID), you’re still required by decorum to acknowledge that there was a reason policymakers resorted to the measures they did. In 2008, the global financial system nearly imploded. In 2020, a literal plague came calling.

We often talk more about the side effects of policy than we do the catastrophe that compelled policymakers to act as they did. To be fair, it’s not the job of analysts to mourn the dead every week, but 50 years from now, when people make charts like the one shown above, the annotation for 2000-2021 won’t read “crypto froth,” or “meme stock mania,” or “US equity bubble.” It’ll read “COVID shock.”

Nevertheless, we’re supposed to lament purported market aberrations. BofA’s Hartnett said negative US real rates are “increasingly responsible for froth in crypto, commodities and US stocks.” The simple figure (below) illustrates the point.

“Financial conditions have just started to tighten as investors acknowledge the froth and anticipate a hawkish Fed in 2022,” Hartnett went on to remark, flagging stumbles for emerging market debt and FX as well as a six-month high on the MOVE.

The next “potential dominoes to fall,” according to Hartnett, are crypto and credit, the “froth” and the “glue,” as he put it. He also suggested the Fed could announce an accelerated taper at the December meeting.

Most importantly, Hartnett called the dollar the “ultimate sign of peak liquidity.” The dollar index is perched at the highest since July of 2020 (figure below).

On Friday, following prepared remarks for a webcast, Richard Clarida said the Fed could discuss speeding up the taper during next month’s policy deliberations.

“I’ll be looking closely at the data that we get between now and the December meeting,” Clarida said. Earlier in the session, Christopher Waller said he favors a faster taper on labor market improvements and rising inflation. He also said the liftoff test has been met on the inflation front. “Sitting around waiting for this to disappear is not necessarily the optimal policy response,” Waller added.

The dollar rose when Clarida’s remarks hit the wires. Earlier this week, one analyst called the greenback’s rise “unstoppable” as long as it’s “justified by strong US data.”

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7 thoughts on “Don’t Forget About The Plague

  1. I’ve almost never met a stock I actually liked but that perfect slide down in real rates starting in 1975 has made me richer than I ever dreamed. I do luv my beautiful bonds. (Remember, different strokes …)

  2. Frankly, I think the policy mistake in 2008-9 was on the fiscal side, not the monetary side. And from then on, everything got out of whack, whacker and whacker.

    But, hey, you had to punish the people for electing a Black man to the presidency…

  3. Here is my question–if you look at the forwards, 1y forwards on nominal rates vs 1y forwards on inflation, say 5yr forward it has a terminal rate of approximately -140bps. So this is beyond what can be considered as transitory or not on the inflation question. This comes at a time when virtually nobody sees any value in owning fixed income, but clearly somebody, somewhere is buying these bonds. Maybe it is because the US is cheaper than the alternatives. Maybe it is the banks who are buying. Maybe it is LDI allocation into Treasuries to insulate their funding ratios. Honestly, it makes little sense unless this permanent word of exception aka Kocic is correct. Maybe it is the size of the debt that makes normalization to positive real rates impossible. My clearly outdated Treasury model has fair value over 2.0%, but I fully expect to be just frustrated by this. I don’t buy TINA. Bonds are expensive sure, but so are stocks, and so is credit. I really don’t get it.

NEWSROOM crewneck & prints