Wednesday 10 October 2018

US real interest rates

10 year real returns went over 1% last week while forward inflation expectations remain anchored (at ~2.25%). 

As such it seems its being mainly driven by the Fed, mirroring how low real returns were engineered by ZIRP/ QE. 

Longer term I deducted a CPI measure from Fed funds to give a real interest rate indicator. Real interest rates have not uncommonly been +4 or 5% and are often in the 2.4-3% range mid to late cycle. 

Adding both together gets a potential neutral rate for the Fed for the real economy of 4.65-5.25%. 

A notable exception was the late 70s where the Fed struggled to keep up with inflation until Volcker hiked Fed funds into the teens to finally kill off inflation. 

But the Fed, given the credit and asset bubble that has been blown up, currently looks like it will try and taper out rate hikes next year with a 3-3.5% range. 

The problem they will have it that might be tight for financial assets, but it will still be loose for the real economy. 

The Yellen Fed wouldn't want to hike enough and risk an asset market crash and the Whitehouse won't want neutral rates for the real economy. 

Powell so far seems more hawkish and the whole set up looks similar to the early 70s.

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