If you are an investor of the Ben Graham school, you’ve lived your life looking for “value” investments with a “margin of safety.” Periodically, if you are a pure value investor, then you go through long periods of pulling your hair out when momentum rules the day, even if you believe – as GMO’s Ben Inker eloquently stated in last month’s letter – that in the long run, no factor is as important to investment returns as valuation.
This is one of those times. Stocks have been egregiously overvalued (using the Shiller CAPE, or Tobin’s Q, or any of a dozen other traditional value metrics) for a very long time now. Ten-year Treasuries are at 1.80% in an environment where median inflation is at 2.5% and rising, and where the Fed’s target for inflation is above the long-term nominal yield. TIPS yields are significantly better, but 10-year real yields at 0.23% won’t make you rich. Commodities are very cheap, but that’s just a bubble in the other direction. The bottom line is that the last few years have not been a great time to be purely a value investor. The value investor laments “why?”, and tries to incorporate some momentum metrics into his or her approach, to at least avoid the value traps.
Well, here is one reason why: the US is the destination currency in the global carry trade.
A “carry trade” is one in which regular returns can be earned simply on the difference in yields between different instruments. If I can borrow at LIBOR flat and lend at LIBOR+2%, I am in a carry trade. Carry trades that are riskless and result from one’s market position (e.g., if I am a bank and I can borrow from 5-year CD customers at 0.5% and invest in 5-year Treasuries at 1.35%) are usually more like accrual trades, and are not what we are talking about here. We are talking about positions that imply some risk, even if it is believed to be small. For example, because we are pretty sure that the Fed will not tighten aggressively any time soon, we could simply buy 2-year Treasuries at 0.88% and borrow the money in overnight repo markets at 0.40% and earn 48bps per year for two years. This will work unless overnight interest rates rise appreciably above 88bps.
We all know that carry trades can be terribly dangerous. Carry trades are implicit short-option bets where you make a little money a lot of the time, and then get run over with some (unknown) frequency and lose a lot of money occasionally. But they are seductive bets since we all like to think we will see the train coming and leap free just in time. There’s a reason these bets exist – someone wants the other side, after all.
Carry trades in currency-land are some of the most common and most curious of all. If I borrow money for three years in Japan and lend it in Brazil, then I expect to make a huge interest spread. Of course, though, this is entirely reflected in the 3-year forward rate between yen and real, which is set precisely in this way (covered-interest arbitrage, it is called). So, to make money on the Yen/Real carry bet, you need to carry the trade and reverse the exchange rate bet at the end. If the Real has appreciated, or has been stable, or has declined only a little, then you “won” the carry trade. But all you really did was bet against the forward exchange rate. Still, lots and lots of investors make precisely this sort of bet: borrowing money is low-interest rate currencies, investing in high-interest-rate currencies, and betting that the latter currency will at least not decline very much.
How does this get back to the value question?
Over the last several years, the US interest rate advantage relative to Europe and Japan has grown. This should mean that the dollar is expected to weaken going forward, so that someone who borrows in Euro to invest in the US ought to expect to lose on the future exchange rate when they cash out their dollars. And indeed, as the interest rate advantage has widened so has the steepness of the forward points curve that expresses this relationship. But, because investors like to go to higher-yielding currencies, the dollar in fact has strengthened.
This flow is a lot like what happens to people on a ship that has foundered on rocks. Someone lowers a lifeboat, which looks like a great deal. So people begin to pour into the lifeboat, and they keep doing so until it ceases, suddenly, to be a good deal. Then all of those people start to wish they had stayed on the ship and waited for help.
In any event, back to value: the chart below (source: Bloomberg) shows the difference between the 10-year US$ Libor swap rate minus the 10-year Euribor swap rate, in white and plotted in percentage terms on the right-hand scale. The yellow line is the S&P 500, and is plotted on the left-hand scale. Notice anything interesting?
The next chart shows a longer time scale. You can see that this is not a phenomenon unique to the last few years.
Yes, the correlation isn’t perfect but to me, it’s striking. And we can probably do better. After all, the chart above is just showing the level of equity prices, not whether they are overvalued or undervalued, and my thesis is that the fact that the US is the high-yielding currency in the carry trade causes the angst for value investors. We can show this by looking at the interest rate spread as above, but this time against a measure of valuation. I’ve chosen, for simplicity, the Shiller Cyclically-Adjusted P/E (CAPE) (Source: http://www.econ.yale.edu/~shiller/data.htm)
Now, I should take pains to point out that I have not proven any causality here. It may turn out, in fact, that the causality runs the other way: overheated markets lead to tight US monetary policy that causes the interest rate spread to widen. I am skeptical of that, because I can’t recall many episodes in the last couple of decades where frothy markets led to tight monetary policy, but the point is that this chart is only suggestive of a relationship, not indicative of it. Still, it is highly suggestive!
The implication, if there is a causal relationship here, is interesting. It suggests that we need not fear these levels of valuation, as long as interest rates continue to suggest that the US is a good place to keep your money (that is, as long as you aren’t afraid of the dollar weakening). That, in turn, suggests that we ought to keep an eye on rates of change: if the ECB tightens more, or eases less, than is priced into European markets (which seems unlikely), or the Fed tightens less, or eases more, than is priced into US markets (which seems more likely, but not super likely since not much is presently priced in), or the dollar trend changes clearly. When one of those things happens, it will be a sign that not only are the future returns to equities looking unrewarding, but the more immediate returns as well.
Durable goods orders, ex-transportation, showed a negative print today for the second time in a row. This was expected, in most senses of the word, but while I don’t put too much weight on short-term wiggles in Durables it is hard to ignore the fact that the year/year change in Durables has now been negative for more than a year (see chart, source Bloomberg).
So the weakness in Durables is not new. But it bears noting that the last time core Durables went negative, in August 2012, the Fed followed with QE3 almost immediately. To be sure, at the time core inflation was all the way down at 1.9%, whereas today it is a heady 2.2%…
Look, any Fed watcher right now is and should be confused. Conditions which provoked QE just four years ago are now apparently spurring a tightening bias. Bill Gross can be excused for thinking that the Fed will go back to the old playbook and employ new QE, as he apparently did in his latest Investment Outlook – it is harder to excuse his saying that the Fed should drop money, given that it hasn’t worked yet.
But clearly, something is different in the way the central bank is approaching monetary policy. After all, nothing about this weakness is new. As noted, Durables have been negative on a year-over-year basis for a full year, and the Citi Economic Surprise index shows that economists have managed to be surprised on the negative side for an unprecedented fifteen months in a row (see chart, source Bloomberg).
Okay, the index technically turned positive once or twice for a day or two, but this is still the longest run of persistently optimistic errors that economists have had in a very long time. So this isn’t new – the economy is weak.
Unless…unless what is different is that in 2012, economists were pessimistic (the Citi Economic Surprise index turned positive right before the Fed started QE, which means that either the data was too strong or economists were too negative) whereas today they are more generally optimistic? It would be entirely consistent with how the Fed has been run for the last couple of decades if monetary policy was not being guided by actual data, but by forecasts of data. (See my book for more on monetary policy errors!)
Evidence is pretty clear that recently economists as a whole have not only been wrong, but wrong in a biased way, which is much worse. If you are merely a bad shot, you miss the target in all kinds of directions. But if you persistently miss the target in one direction, then it may well be that your weapon sights are not properly calibrated. The first sort of unbiased miss is not as dangerous, even if too much confidence is placed on the shot, because the errors will even out over time. You might eventually hit the target, by accident. But if the target sights are biased, then you will never hit the target until you realize you’re wrong. You would be tightening when you should be easing. A broken clock is right twice per day, but only if it is stopped and not just systematically two hours off.
Now, regular readers of these columns will understand that I don’t think the Fed should be easing. I don’t think the Fed can fix what ails growth, since monetary policy only affects the price variable, and easy money has only created the conditions for the inflationary upswing we are currently experiencing (Gross also acknowledges this, but sees the inflationary upswing somewhere in the unthreatening future while in fact it is here now). The Fed should have eschewed QE2 and QE3, and have long since begun to drain excess reserves. But what I think the Fed should do and forecasting what I think they will do are two very different things.
I suspect Gross is close to right. Absent some recovery in the real economy – something other than payrolls, which as we know lag – it strikes me as unlikely the Fed will be hiking rates again. Ironically, that may help keep inflation leashed for longer since it will help keep monetary velocity constrained – but I am not confident of that, given how low interest rates already are. Since inflation is very unlikely to wane any time soon, I think we are more likely to see the yield curve steepen from these levels, rather than flatten. A yield curve inversion is not a prerequisite for recession. Inverted yield curves tend to precede recessions only because the Fed is typically slow to lower interest rates in response to obvious weakness. In this case, rates are already low and the Fed isn’t likely to raise them and force a curve inversion. Yield curve inversions are not causal! This next recession may catch some people wrong-footed because they keep waiting for the inversion that never comes.
In my next article, I am going to revisit an issue I first addressed a couple of years ago and which might be especially relevant as recession possibilities increase: the question of how we can have both deflation and inflation, and how these concepts are often confused by those people who are stuck in the nominal world.
I am sure that in my career I have seen weirder reactions, but when the Durable Goods number came out and plainly was significantly weaker-than-expected and energy rallied I must admit it was hard to think of one.
Presumably the reaction was an indirect one: weaker growth means the Fed is less likely to tighten, which means a lower dollar and hence, higher global demand for oil. But that seems a wild overthink. If there is a recession in the offing, and if we care about demand in oil markets (and I think we should), then weak economic growth from one of the world’s largest economies probably ought to be reflected in lower oil prices.
There is part of me that wants to say “maybe investors have finally realized that any given month of Durable Goods Orders is almost meaningless because the volatility of the number makes it hard to reject any particular null hypothesis.” I haven’t done this recently, but many years ago I discovered that a forecast driven by the mechanical rule of -0.5 times last month’s Durables change had a better forecasting record than Street economists. Flip the sign, divide by two. However, I don’t really think the market suddenly got wise.
I also don’t think it’s that a bunch of people got the API report, which came out at 4:30pm to subscribers only, early. That report supposedly showed a large draw in crude inventories when a build was expected – but I’m not into conspiracy theories. That would be too obvious, anyway.
The perspective of analysts on Bloomberg was that the oil market will “rebalance” this year, a point which isn’t very far from the point I made last week in my article “Don’t Forget Oil Demand Elasticity!” But rebalancing doesn’t mean that prices should go higher. They have, after all, already gone quite a bit off the lows. By our proprietary measure, the real price of oil is at a level which implies a 10-year expected real return of about 1% per annum. In other words, it’s within about 10% of fair value quantitatively; given the immense supply overhang that doesn’t seem to promise lots of upside from these levels.
It isn’t just energy. The Bloomberg Commodity Index is 15% off its January lows (see chart, source Bloomberg). Precious metals, industrial metals, softs, grains, and meats are all above their lows of the last 1-2 quarters.
Unfortunately, much of this is simply a function of the dollar’s retracement. The chart below (source: Bloomberg) shows the Bloomberg Commodity Index (left axis, inverted) against the broad trade-weighted dollar. Heck, arguably commodities are still lagging.
But the winds of change do seem to be about. Last week, the Treasury auctioned 5y TIPS; though this isn’t an event in and of itself, the fact that the auction was strongly bid is certainly unusual. The 5y TIPS are a difficult sell. People who are concerned about inflation are typically looking to protect against the long-term. But TIPS also represent real interest rate risk, and if you think inflation is going to be rising near-term then you probably don’t want to own lots of interest rate risk. Sure, you’ll prefer inflation-linked real rates to nominal rates (see my timely comment from January, “No Strategic Reason to Own Nominal Bonds Now”: since then, 10y real yields have fallen 40bps while 10y nominal yields have fallen 7bps), but if you really think inflation is about to rear its ugly head then you don’t want any real or nominal duration but only inflation duration.
And inflation duration has lately been doing really well. The chart below (source: Bloomberg) shows the marked rebound in the 10-year breakeven inflation rate since February 9th.
I think there’s some evidence that the pendulum of complacency on inflation has begun finally to swing back the other way. Core inflation is rising in Europe, the UK, Japan, and the US, and it was inevitable that someone would notice. Ironically, it took energy’s rally to make people notice (and energy, of course, isn’t in core inflation). But what do I care?
If in fact the pendulum of complacency and concern has finally reversed, then both stocks and bonds are in for a rough ride. Bonds may be marginally protected by a dovish Fed, but that only works as long as the inscrutable Fed stays dovish…or inscrutable.
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(**Administrative Note: Get your copy of my new book What’s Wrong with Money: The Biggest Bubble of All! Here is the Amazon link.)
In the long list of nightmares that market risk managers have to wrestle with on a daily basis, some have gradually receded. For competently-run banks and large trading institutions, the possibility of a rogue trader making undiscovered trades or mis-marking his own book – another Nick Leeson – is increasingly remote given the layers of oversight. But one nightmare in particular has been increasing in frequency since 2009, especially as Volcker Rule and Dodd-Frank restrictions have been implemented.
The concern is market illiquidity. Every year that goes by, liquidity in the financial markets is declining. This is not apparent to the casual observer, or casual investor, who faces a tight market for his hundred- or thousand-lot. But probably every institutional investor has a story of how his attempt to hit a bid on the screens resulted in his trading the minimum size while the rest of the bid fled with sub-millisecond dispatch. And so the question is: if your mutual fund is hit by redemptions at the same time that its market (equities, emerging markets, credit?) is falling apart – and that is the normal time that redemptions swell – then at what price will it be able to get out? And what if there is no bid at all that is big enough?
Banks and other dealing institutions have responded to both the new regulatory restrictions themselves, and to the effects of the restrictions, by decreasing the size of their balance sheet dedicated to trading. Much of the apparent ‘liquidity’ in the market now is provided by the algos (the algorithmic trading systems) who as we have seen can be there and gone in an eyeblink. I am not aware of anything that has been done in the wake of the various “flash crashes” we have seen that would lead me to have great confidence that in the next big market discontinuity markets will function any better than they did in 2008. In fact, public liquidity is quite a bit smaller and I would expect them to function a fair bit worse.
Yes, many institutions have begun to access “dark pools” where they face anonymous counterparties in crossing large trades, rather than chasing hair-trigger algos for a fraction of the size they need. But nothing is particularly soothing about the dark pools, either (starting with their name). The whole point of a market discontinuity is that flow traders end up all on the same side of the flow; in these times we want the speculative traders with big balance sheets to take the other side of trades at a price that reflects a reasonable return on their capital. Those spec traders, or at least the big-balance-sheet banks, aren’t providing extra liquidity in dark pools either.
Banks have also responded to the beat-down regularly administered by socialists like Bernie Sanders and by sympathetic ears in the press (and among the populist splinters of the right as well) – by cutting the experienced and expensive traders who have more experience in pricing scarce liquidity, and perhaps finding it sometimes. Again, none of this makes me optimistic about how we will handle the next “event.”
None of this rant is new, really. But what is interesting and new is that the illiquidity is starting to show up in very visual ways. Regular readers know that my primary area of domain expertise is in rates, and specifically in inflation. Consider the chart below (source: Enduring Investments), which I would consider strong evidence that market liquidity in inflation is worse now than it was two years ago. The chart shows 1-year inflation forward from various points on the inflation curve. That is, the point on the far left is 1 year inflation, 0 years forward (in other words, today’s 1-year inflation swap). The next point is 1 year inflation, 1 year forward. And so on, so that the last point is 1 year inflation, 29 years forward.
Ignore the level of inflation expectations generally – that isn’t my point here. Obviously, inflation expectations are lower and that is not news. But the curve from two years ago shows a nice, smooth, “classic rates derivatives” shape. Inflation is priced in the market as rising in smooth fashion. This doesn’t mean that anyone really expects that inflation will rise smoothly like that; only that such is the best single guess and, moreover, one that has nice characteristics in terms of derivatives pricing and transparency.
The blue curve shows the curve from last Thursday. Now, I could have chosen any curve in the last month or two and they would have been similarly choppy. You can see that the market is evidently pricing in that inflation will be 1.72% over the next year, and then decline, then rise, then decline, then rise irregularly until 9 years from now when it will abruptly peak and descend.
That’s a mess, and it is an indication that liquidity in the inflation swaps market is insufficient to pull the curves into a nice, smooth shape. This is analogous to one important characteristic of a planet, from an astrophysicist’s point of view: any body that is not sufficiently massive to pull itself into a sphere is not a planet, by definition. I would argue that the inability of the market to pull the inflation curve into a nice and smooth “derivatives” shape is an early warning sign that the “mass” of liquidity in this market – and in others – is getting worse in a visually-apparent way.
Would you rather have a bar of chocolate today, or one year from today?
Most of us, if we like chocolate, would prefer to have a bar of chocolate today rather than at some point in the future. If you don’t care for chocolate, how about money? Would you rather have $100 today, or $100 next year?
The reason that Wimpy’s “I’ll gladly pay you Tuesday for a hamburger today” ploy doesn’t work is that we would prefer to have the money today compared to the money on Tuesday. If Wimpy wants his burger today, but doesn’t have the money for it, then he must borrow the money and pay that money back on Tuesday. Because of our time preference for money, this will cost Wimpy something extra, as he needs to incentivize us to part with the money today so that he can get his burger now.
This is where it gets weird.
We are now in a Wimpy world. Not only can Wimpy get his burger today, it costs him less if he borrows the money because interest rates are negative. That is, “I’ll gladly pay you less money than the burger costs, and not until Tuesday, for the burger today.” And we are enthusiastically answering, “Sure! Sounds like a great deal!”
This is one weird implication of negative interest rates. If the yield curve was flat at a negative interest rate, it would imply that the further in the future something is, the more valuable it is. A dollar next week is worth more than a dollar today. With negative discount rates, a chocolate bar next year is preferable to a chocolate bar today. And poor Wimpy…being forced to have a hamburger today when a hamburger on Tuesday would be so much better!
It gets even weirder if the yield curve is initially negative but slopes upwards and eventually becomes positive. That implies that discount rates (time preferences) are negative at first, but then flip around and become normal at some point in the future. So there is one day in the future where value is maximized, and it’s less valuable to get money after that date or before that date.
You think this is mere theory, but this is happening internally to derivatives books even as we speak. The models are implying that money later is worth more than money now, because money now costs money to have. And from the standpoint of bank funding, that is absolutely true.
Another strange implication: in general, stocks that do not pay dividends should trade at lower multiples (relative to the firm’s growth) because, being valued only on some terminal cash flow date (when a dividend is paid or when the company is bought out), they’re worth less. But now it is better for a stock to not pay dividends; those dividends have negative value. Technically speaking, this means that companies which cut their dividends should trade at higher prices after the cut.
I can think of more! Ordinarily, if your child enters college the institution will offer you an incentive to pay four years’ tuition at a reduced rate, up front (or at a frozen rate). But, if interest rates are negative, the college should demand a premium if you want to pay up front. Similarly, car companies should insist that you take out a zero-interest-rate loan or else pay a premium if you feel you must pay cash.
In this topsy-turvy world, it is good to be in debt and bad to have a nest egg.
Neighbors appreciate you borrowing a cup of sugar and frown at you when you return it.
Burglars put off burglaries. Baseball teams sign the worst players to the longest deals. Insurance companies pay out life insurance before you die.
And all thanks to negative interest rate policies from your friendly neighborhood central bank. I will thank them tomorrow, when they’ll appreciate it more.
The news on Friday that the Bank of Japan had joined the ECB in pushing policy rates negative was absorbed with brilliant enthusiasm on Wall Street. At least, much of the attribution for the exceptional rally was given to the BoJ’s move. I find it implausible, arguably silly, to think that a marginal change in monetary policy by a desperate central bank on the other side of the world – however unexpected – would have a massive effect on US stocks. Subsequent trading, which has reversed almost all of that ebullience in two days, suggests that other investors also may agree that just maybe the sorry state of earnings growth rates in this country, combined with a poor economic outlook and still-lofty valuations, should matter more than Kuroda’s gambit.
To be sure, this is a refrain that Ben Bernanke (remember him? Of helicopter infamy?) was singing last month, before the Federal Reserve hiked rates impotently, and clearly the Fed is investigating whether negative rates is a “tool” they should add to their oh-so-expansive toolbox for fighting deflation.
Scratch that. The Fed no longer needs to fight deflation; inflation is at 2.4% and rising. The toolbox the Fed is interested in adding to is the one that contains the tools for goosing growth. That toolbox, judging from historical success rates, is virtually empty. And always has been.
Back to Japan: let me point out that if the BOJ goal has been to extinguish deflation, it has already done so. The chart below (source: Bloomberg) shows core inflation in Japan for the last 20 years or so. Abstracting from the sales-tax-related spike, core inflation has risen fairly steadily from -1.5% to near 1.0% since mid-2010.
They did this, very simply, by working to accelerate money supply growth from the 1.5%-2.0% growth that was the standard in the late pre-crisis period to over 4% by 2014 and 2015 (see chart, source: Bloomberg).
Not rocket science, folks. Monetary science.
Now, recently money supply growth has begun to fall off, so the BoJ likely was concerned by that and wants to find a way to ensure that inflation doesn’t slip back. If that was their intention, then cutting rates was exactly the wrong thing to do. The regression below (source: Bloomberg) illustrates in a different way what I have shown here before: interest rates and money velocity are closely tied (as Friedman explained decades ago). The r-squared of this relationship – assuming that functionally a linear fit is appropriate, which I am not sure of – is a heady 0.822.
You may notice the data is from the US; that’s because Bloomberg doesn’t have a good velocity series for Japan’s M2 but the causal relationship is the same: lower term interest rates imply less reason not to hold cash.
Now, it may be the case that this relationship ceases to apply at negative rates even though the idea is based on the relative difference between cash yielding zero and longer-term investments or consumption alternatives. The reason that velocity might behave differently at sub-zero rates is that people respond asymmetrically to losses and gains. That is, the pleasure of a gain is dominated by the pain of the same-sized loss, in most people. This cognitive bias may cause savers/investors to behave strikingly different if they are charged for deposits than if they are merely paid zero on those deposits (even if zero is lower than other available rates). In that case, we might see a spike in money velocity once rates go through zero as cash balances become hot-potatoes, just as if investment opportunities suddenly appeared. And rates, not just overnight but term rates, just went negative in Japan. The chart below (source: Bloomberg) shows the 5y JGB rate.
- The speculation that sub-zero rates might cause a rise in velocity is just that: speculation. There’s no data to suggest that this effect exists.
- Frankly, I suspect it doesn’t, but it’s possible. However, if it does I would expect it to be a spot discontinuity in the relationship between rates and velocity. That is, the behavior should change between 0% and some negative rate, but then be somewhat linear thereafter. Cognitively, the reaction is both a general loss aversion, which is linear but no different at negative rates from zero, and a behavioral “endowment” reaction that is to the “taking” of money from a person and not necessarily related to the size of the theft.
- If it does exist, it still doesn’t mean that cutting rates to a negative rate was wise. After all, quantitative easing has done a fine job of pushing up inflation, and so there is no reason to take a speculative gamble like this to keep inflation moving higher. Just do more of the same. Lots more.
- More likely, the BoJ is doing this because they believe that negative rates will stimulate growth. This is much more speculative than you might think, and I may be overgenerous in phrasing the point that way. In any case, any growth benefit would stem either from weakening the currency (which QE would also do, with less risk) or from provoking investment in more marginal ventures that become acceptable at lower financing rates. We call that malinvestment, and it isn’t a good thing.
- Whatever the point of the BoJ’s move, the size of any growth effect from currency reactions is utterly dependent on the reaction function of trading counterparties. If other countries seek to devalue their currencies as well, then the whole operation will be inert.
So, will the BoJ’s move save US stocks? Heck, it won’t even save the Japanese economy.
Today I presented our 2016 inflation forecast to the investment committee for a multifamily office, and when I was putting the presentation together I developed one slide that really is a must-see for investors in my opinion.
For some time, TIPS have been too cheap. Really, it has been more than a year that our metrics have shown inflation-linked bonds as not just cheap, but really cheap compared to nominal bonds. I don’t mean that real yields will fall – so this isn’t a statement about whether I am bullish or bearish on fixed-income. Frankly, I am somewhat conflicted on that point at this moment.
Rather, it is a statement about what sort of fixed-income instruments to own, for that part of your portfolio that needs to be in fixed-income. If you are running a diversified portfolio, then you can’t really avoid owning some bonds even if you are bearish on the bond market. For risk-reduction reasons if for no other, it makes sense to own some bonds.
But you don’t have to own fixed-coupon nominal bonds (or, for that matter, floating-coupon nominal bonds which are still exposed to inflation through the principal of the instrument). In fact, right now it is hard for me to imagine betting on nominal bonds for the portion of my portfolio that is in fixed-income.
A picture is worth a thousand words, so here is the picture:
The chart shows rolling, compounded 10-year inflation rates for as far back as we have reasonable data. And it shows the current level of 10-year inflation “breakevens.” What this means is that if you are long Treasuries, rather than TIPS, you will do better over the next ten years if inflation is below 1.34% and above roughly zero. If we have big deflation, TIPS will do just about as well since they are also principal protected; if we have any inflation over 1.34%, TIPS will do better.
And as the chart points out, since the Fed has been formed we have literally had almost zero 10-year periods in which inflation was in the 0-1.34% zone. Perhaps the 10-year periods ending early in the Great Depression, en route to big deflation, or coming out of the Great Depression heading into WWII. But otherwise, inflation has always been either higher or, in a Fed-screw-up scenario, much lower.
Put another way, it means that if you choose to own nominal bonds instead of inflation-linked bonds for the next 10 years, you are short a straddle on inflation, and you’re not being paid much to be short it. (Technically, you’re short a zero-cost ratio call spread since you don’t lose in deflation, but I’m trying to keep it simple!)
There may be tactical reasons to prefer nominal bonds to inflation-linked bonds. But to me, there is no clear strategic reason to be long nominal bonds for that portion of your portfolio that you intend to keep in fixed-income.