Economists regards real yields as a market mover in this summer. Real yields are linked with the yields on Treasury inflation protected securities, or TIPS. They can be measured as alternatives by looking at the yields on TIPS.
"TIPS is a type of Treasury security issued by the U.S. government that is indexed to inflation in order to protect investors from a decline in the purchasing power of their money. The principal value of TIPS rises as inflation rises while the interest payment varies with the adjusted principal value of the bond. The principal amount is protected since investors will never receive less than the originally invested principal." - Investopedia
*Real yield = Nominal yield - (break-even) inflation rate
*Break-even inflation rate = Nominal yield - Real yield
For example, if an investor buys an ordinary 10-year treasury notes, he can have possibility to lose about -0.9% in annualized basis since nominal yields on 10-year treasury notes is 0.67% and break-even inflation rate is 1.65% according to Federal Reserve Bank of St.Louis.
However, it is very difficult for the nominal interest rate to fall below 0.10%, since interest rates on excessive reserves(IOER) on Fed is set at the target. If yields on Treasury notes falls below 0.10%, banks may be reluctant to buy any bond; they will rather lend it to the Fed. (The bond interest rate, the market rate, the yield on treasury notes, etc. are all applied in the same concept)
Of course, not everyone can deposit at a 0.10% interest rate in the Fed, so it would not be impossible for nominal interest rates to fall below 0.10%. Financial institutions, which are not eligible to save their capital to the central bank, must somehow keep large amounts of cash in a safe place and keep them in line with their debt structure for quite a long time; there is no alternatives than government bonds. But anyway, assuming that 0.10% is the primary lower limit of nominal interest rates, real interest rates are principally determined by (break-even) inflation rate.
For example, if the nominal 10-year treasury note yield falls to 0.10%, break-even inflation rate in the bond market will rise to 2.10% then the real return on the same maturity falls to -2.0%.
In August, real yields were likely to reach the downward limit. When the minutes of the FOMC discussions were released in July, the US mid- to long-term treasury bond yields jumped. The yield on TIPS has risen even more. Naturally, the government bond market's expected inflation declined. In other words, a dis-inflationary movements were unfolded as the financial market environment tightened after the announcement of the FOMC minutes. The dollar jumped and the gold price plummeted.
The financial market had been expecting the FOMC to clarify its forward guidance on zero interest rates and more of supportive asset purchase policies on upcoming September. Keeping zero interest rates until inflation exceeds the 2% target was almost certain.
Yet, Fed only suggested the time to clarify the guidance on the path of interest rate policy as "at some point." It became unclear that Fed will ease the monetary policy this September. There could be no lower interest rate, and even if the Fed alone does something more, it won't help the unemployed who worked in restaurants, bars, hotels and theaters. The absence of Fed's leadership of economic stimulus eventually produced graphs of lowering break-even inflation rate whereas real yields rise slightly.
Nonetheless, Fed announced about monetary policy plans, remaining federal funds rate near zero until average inflation reaches and remains over 2 percent "over time". Please see my blog down below.
https://techongstudy.blogspot.com/2020/08/review-of-monetary-policy-strategy-fed.html
This overall means owning Treasurys are not considered attractive since the stocks, gold, or corporate bonds can be an alternative that is likely to have more potential positive return. After Fed's super dovish monetary policy which is also supported by U.S. Treasury's fiscal policy, real yields have turn negative due to the short term interest rate near zero. This factor has encouraged investors to take risk-on mode and expose themselves to stock market, commodities or riskier trading field.
There are several reasons that real yields matter to the consequences below:
After Fed cuts FFR to zero due to pandemic hit, negative real yields were purposely driven, since the central bank has been buying Treasury bills and has given the signal targeting above 2% average inflation target(AIT) over time. The stance of Fed has given the effect of capping Treasury yields since long-term yields tend to follow short-term interest rates. This has given investors more confidence that Fed will allow inflation for long period of time, so the real yields have dropped.
Stocks & High yields
For the Fed, low real yields aren’t the only weapon for hiking asset price. For the anticipation of Fed's intervention on economy cushion, yield spread between Treasury and investment-grade corporate bond is below its 10-year average, despite the pandemic. It helped companies to issue more amount of bonds in that short period of time, which enabled companies to keep on paying the workers and investments. Stocks also skyrocketed by negative real yields.
Dollar & Gold
Lower yields drop lays consequences on weakening dollar. The interest rate is the price of money. The quantity of money increases and decreases in the movement of the interest rate. When the money is overly supplied, then the value diminishes putting the price downwards. When the real yield of U.S. is higher than other countries, then the dollar gains its strength.
Thus, the decline of in U.S. real yields compared with German real yields has helped strengthen the euro against the dollar. Similar to bonds, gold is an asset that investors seek for safety. It also tends to soar during acceleration of inflation. because it then takes more dollars to purchase the same amount of the precious metal. Please see my blog below.
https://techongstudy.blogspot.com/2020/08/can-gold-and-silver-be-considered-as.html
Source: Global Monitor, WSJ
https://www.facebook.com/globalmonitor.kr.1?epa=SEARCH_BOX
https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield
https://www.wsj.com/articles/real-bond-yields-help-explain-surprising-market-moves-11600090704?mod=markets_lead_pos3
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