Peak real fed funds rate will likely be negative this cycle. Are negative real yields becoming permanent?
“it’s a long road to normal from where we are.”
Fed Chairman Powell
“100% of the time that the Fed tightens into a #Quad4, markets crash.”
As debt increasingly replaced productivity as the main growth driver, long term growth has been declining for 70 years to critically low levels.
The chart below shows that historically real rates usually reached somewhere around real GDP in order to contain inflation, but then also initiated a recession shortly after. Remarkably, Volcker took real rates to 11% in 1981 and precipitated a deep recession to break the back of the 1970s inflation.
The chart also shows that ever since 1981 the peaks in real rates have been declining to just 1% in 2018.
The “most reckless Fed ever” took the real Fed funds rate to a record low -8%! Positive real interest rates have never been further away.
The bond market is already indicating that in the current cycle the yield curve not only steepened to a lower peak, it has also inverted even before interest rates rose at all! The bond market is signalling that in underlying terms the economy is weak in the absence of extreme policy measures.
The yield curve inversion is very consequential for equities. Look at the track record and the strength of this signal.
Are Central Banks (BIS) going from extreme policy stimulus to …..cold turkey? Or just impotence? They have certainly changed their language…
“Time to Ignite all engines”
BIS June 2019
“The world economy must learn to rely less on expansionary monetary policies.”
BIS April 2022
Challenging investment conditions favors tight risk management with some quality real assets. The chart below shows that gold performs well when real interest rates are negative and falling. As soon as Treasury bonds can stabilize gold should perform well.
Treasury Inflation Protected Securities now have some positive real yields and the benefit of inflation on top which looks like an attractive option over time.
Currently the outlook is for continued weak grow through Q1 2023 with three of the next four quarters in quad 4, declining growth and inflation. Inflation is more uncertain but should peak in the current quarter and fall to around 5 1/2% by year end.
Inflation likely stays well above most expections for bond yields and Fed fund rates for the remainder of the year.
Weak growth will limit interest rate rises. The Bank Of England mentioned it as a concern on May 5 even as it raised interest rates to 1% and forecast 10% inflation at the end of 2022!
Get used to negative real rates!
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