Morning Commentary: Real Negative Rates

A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.

Real Negative Rates Share this story: Andrew Kositkun Senior FX Advisor

Ten-year real interest rates in the U.S., Canada, the U.K., Japan, Germany, Spain, Italy and Australia are all below 0%, with some deeply in negative territory. Conversely, consensus global growth expectations are very strong for the next two years. This creates a curious disconnect between real rates and expectations on growth and begs the question of whether or not the real rate markets are sending a dire warning about the future of global economies.  In short, the answer is mostly no. For the most part, the current run of negative real rates represents the distortion created by central banks that have extended their influence beyond overnight rates into long-term nominal rates by adopting forward guidance, QE and yield-curve targeting. As such, negative real rates around the world are a result of low nominal rates, as determined by central banks and “normal” levels of inflation and inflation expectations determined partly by central banks but largely by factors outside the control of central banks.  One way to look at the real rates market is to see it as a residual. That is, 10-year real rates equals 10-year nominal rates minus 10-year inflation expectations. As such, real rates will be negative whenever inflation expectations are above nominal rates and vice versa. When looking at real rates in the U.S., the EU, the U.K., Japan, Canada and Australia, it is Japan that has the highest real rate despite having a nominal 10-year yield of only 0.05%. This is because it has the lowest inflation expectations. Thus, having the highest real rate across developed markets is not indicating something positive about the outlook for Japanese growth, but rather, it stems from bad news over the inflation outlook.  So while the disconnect between real rates and growth might not be a warning about future growth, there are still costs to low rates and rising inflation pertaining to the risk of asset bubbles. With the Fed in uncharted waters on several fronts, Fed Chair Jay Powell has acknowledged that the central bank does not quite believe that reducing monetary policy stimulus would help prevent bubbles and is unclear on the trade-off between preventing bubbles and slowing the economic recovery. What is clear is that very easy monetary policy leads to very low nominal rates and rising inflation expectations, which lead to negative real rates for the foreseeable future.  HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: The U.S. dollar continues to strengthen with the dollar index hitting its highest level since Dec. 2. Accordingly, EUR/USD has broken below the psychologically important 1.20 level on the interbank market. Recent comments out of European Central Bank officials have pushed back on euro strength, with relatively larger fiscal stimulus and better vaccine distribution in the U.S. set to see U.S. growth outpace European growth.  On the stimulus front, Democrats are looking at reducing the number of households that qualify for the $1,400 stimulus check by lowering the income threshold. The House also passed a 2021 budget resolution to keep President Biden’s $1.9 trillion plan on the fast track. The Senate plans on voting on an identical version of the resolution later this week, with the House potentially holding a vote on the final version by Feb. 23.  Initial jobless claims came in better than expected, as the series printed 779,000 claims against expectations for 830,000 claims. Last week’s reading was also revised down to 812,000 claims from the original 847,000 print, increasing the size of this week’s overall beat. Tomorrow brings the important government nonfarm payroll jobs report.  The Bank of England kept rates unchanged as was widely expected. In a bit of double speak, the bank pushed back against the importance of any prep work done on negative rates by saying on multiple occasions that it has no intentions to go negative at the moment, but it also said that it was ready to take rates negative if needed. Additionally, the bank also suggested that the true jobless rate is higher than the official number due to distortions created by the government’s labor market support programs.

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