Real interest rates dropping back again

Good news for gold and tech stocks

Chart of the Day

One of the key developments in the first week or so of 2021 was the rise in US real interest rates, which was causing problems for those assets most sensitive to real rates, like gold and tech stocks. That trend has reversed in the past week, with an increase in inflation expectations and essentially unchanged nominal bond yields causing real rates to fall . As this chart shows, the latest decline (the green line is inverted) has been good news for gold, which rose by another 1.4% yesterday, although it remains some way below its level at the start of the year.

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Macro

US homebuilder confidence appears to be normalizing, perhaps reflecting concerns the recent rise in nominal interest rates will push up mortgage rates

Inflation unexpectedly dropped in Canada in December, back below 1% - core inflation there remains close to 2% though.

In the UK, core inflation rose to 1.4% in December and might be set to rise a bit further.

The Bank of Canada met yesterday and kept rates at 0.25%, while Brazil’s central bank kept its rate at 2.0%. Today, the Norges Bank and ECB also look set to keep their policy rates unchanged at 0% and -0.5% respectively. Despite having the highest nominal rate, in inflation-adjusted terms Brazil’s policy rate is among the lowest in the world.

Markets

We saw above that the 10-year real TIPS yield has dropped back and, as this chart shows, the 5-year has moved even more sharply to a new cycle low.

Real yields have declined due to further increases in inflation compensation - nominal yields have been relatively stable.

The drop in real yields has been good news for equities, especially the tech-heavy Nasdaq which jumped by 2% yesterday.

The smaller rise in the S&P 500 was also mainly due to the key tech sectors. By contrast, the cyclical sectors such as financials were less impressive.

Implied volatility has dropped back to its recent lows and the coincident decline in the VVIX seems to suggest there isn’t an imminent danger of a reversal. Of course, low volatility itself can eventually beget instability by prompting traders to utilize greater leverage and take on riskier positions.

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