Positive Real Rates in Sight
Macro Perspectives
In recent days we've talked about the signal the decline in the 10-year Treasury yield might be giving us.
It closed another 10 basis points lower, at 3.42%. At the low of the day (07 Dec 22), the most important market-determined interest rate in the world was down almost a full percentage point from the highs of late October.
This, as the Fed has been trying to set expectations for a stopping point in this tightening cycle (for the short term interbank lending rate it sets), somewhere around 5% - that's about a full point higher than the current Fed Funds rate.
Again, market-determined interest rates are going the other way. This move in the 10-year yield started on Wednesday of last week, when Jerome Powell told us "I don't want to over tighten."
With that, as we've discussed here in my daily notes, there are reasons to believe that the Fed has already over-done it. Instead of slowing the rate-of-change in prices (inflation), we may find it has induced a decline in prices (deflation).
We know from real-time CPI inputs (like new and used cars, rents) that prices have been rolling over for months. The government's report hasn't reflected it ... yet.
With this in mind, an astute Macro Perspectives reader (and very good portfolio manager) reminded me yesterday, the Fed historically hasn't stopped a tightening cycle before taking the Fed Funds rate above the rate of inflation (headline CPI).
This is the condition of "positive real rates" (Fed Funds rate - inflation rate) Powell has talked about.
With that, if the Fed did nothing further from this point (stopped where they are), and the rate-of-change in prices was zero from this point, how long would it take to get to positive real rates? Let's take a look ...
So, in this scenario, if the monthly change in prices went to zero (i.e. headline CPI stayed unchanged) over the coming months, by March we would have positive rates.
That said, with key inflation inputs rolling over, AND persistently lower oil prices, we could see negative monthly price changes in the coming months, which could get us to positive real rates sooner than March.
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