# Various indicators are getting interesting

USD/JPY touched 84.73, a 15-year high for the Japanese currency. Hugh Hendry thinks it would have to reach the low 70s for the BoJ to “go nuclear”.

Here is a little trivia question for you. When was the last time 2-year U.S. Treasury notes yielded less than 0.5%? Answer: Today. Before that, last Friday. Before that, never.

And my favorite: 5-year TIPS traded yesterday at a negative real yield. Accepting a negative real yield is irrational almost by definition, because you would earn a higher return (0%) simply by buying something real and sitting on it. What the heck?

Felix quotes Scott Granis with one explanation:

You can think of real yields on 5-yr TIPS as a good proxy for the marketâ€™s expectation for real GDP growth, mainly because there should be some reasonable connection between the risk-free real yield an investor can earn on TIPS over the next 5 years and the real yield on cash flows tied to the economyâ€™s performance via generic equity exposure.

But that sounds like total nonsense to me. GDP is itself already a rate of growth. The cash flows you get from an investment in the “general economy” are tied to GDP, not GDP growth. (Just like the cash flows you get from owning a business are tied to its earnings, not its earnings growth.)

Felix then provides his own explanation:

I donâ€™t think that the TIPS market is pricing in zero real GDP growth over the next 5 years. But I do think it reflects worries over stock-market valuations.

I myself can think of two explanations.

First, TIPS are not linked to inflation; they are linked to “inflation”, as measured by the CPI. The CPI is not inflation; the CPI is a government statistic. If you think the CPI is going to overstate inflation for the next five years, or if you think the cost of the stuff you personally care about will rise more slowly than the CPI, you could rationally purchase TIPS at a negative yield.

My second explanation is along the line of Felix’s, but I would go further: If you are unable to identify an asset which you are confident will appreciate as least as quickly as the CPI, then again you could rationally purchase TIPS at a negative yield. (Can you name such an asset? Go ahead; I dare you.)

In my view, the negative TIPS yield is saying something about the perceived levels and volatility of traditional inflation hedges such as stocks, real estate, and gold. If these valuations and/or volatilities are high enough, rational people might well be willing to sacrifice some slight amount of real wealth for the relative certainty of preserving most of their purchasing power.

In short, the negative TIPS yield is a rational reaction to the lunatic casino that has infested essentially every market in the world.

### 7 comments to Various indicators are getting interesting

• jesse

I could just buy a basket of goods tracked by CPI. No wait, hedonics deflates them. Crap.

• mjturner

Accepting a negative real yield is irrational almost by definition, because you would earn a higher return (0%) simply by buying something real and sitting on it.

I’m not sure that is true. Real assets, houses, gold, etc don’t magically appreciate in real terms. What’s irrational is accepting a nominal negative yield, as you could just hoard cash (although there is a security risk). But a positive nominal yield is not so bad, surely?

• Nemo

If you purchase TIPS at a negative real yield, and the CPI comes in zero or negative, then you will also lose money in nominal terms. TIPS are only guaranteed to give you your money back in nominal terms if you buy them with a positive yield.

Over on Felix’s site, some guy says, “Nemo also forgot to add back the option premium when trying to infer a real yield from a TIPS yield”. He is talking about the “floor” on the TIPS payment multiplier. When you buy TIPS at auction, the coupon payments and final principal payment are indexed to the CPI, but they never go below their original value even if the CPI comes in negative.

No, I did not forget; I just considered it part of my point. My point is that the certainty of TIPS returns, relative to the uncertainty of everything else, can make them attractive even if they are guaranteed to lose value in real terms. It is the valuation and volatility of the alternatives that makes this possible.

The floor on the TIPS multiplier is just sauce for this goose.

• Gold does well when real returns are low, and it will most likely provide a good hedge against inflation over long time horizons. Don’t even think of trotting out the 1980 Gold/CPI comparison on that one. I hope you realize that’s a garbage cherry-picked number.

And insofar as the market has become a “lunatic casino”, might that instead be a symptom of demographic collapse and low real rates?

• What real thing could you buy with 0 chance of depreciating at all?

• s/GDP growth/growth in the value of publicly traded companies/g

• Along the lines of “inflation” vs inflation: TIPS are not an economic forecasting tool, they have a prospectus and TIPS exposure grew a lot as finance professors recommended over the last X years to their students and in media publications that they are the perfect investment for most people. (Someone wrote a book ~7 years ago saying almost exactly that.) So a lot of demand [at any price] for TIPS could be due to dynamics like that.