Friday, February 17, 2012

The absurdity of negative real treasury yields

Treasuries are continuing to price a significant "risk premium" with real yields heavily in the negative territory. To hold an instrument that locks one up for 10 years at -1% real yield (assuming inflation stays at current mild levels) makes little sense unless the instrument is used purely as protection against a crisis. Based on recent historical data the "Europe risk premium" is at least 200bp or higher.

Headline US CPI vs. 10-year treasury yield

Even when considering the core CPI number, the risk premium (and negative real yield) is quite material. In the last couple of years 10-year treasury yields have been running at some 250bp above the core CPI. Now the yield is visibly below the core CPI number.

Core US CPI vs. 10-year treasury yield

The absurdity of this disconnect can be seen by comparing the US to Japan. Japanese10-year real yield is actually positive - over 100bp (90bp nominal yield, with -20bp CPI). A holder of 10-year JGBs makes some 200bp more than a holder of US treasuries in real terms. Such discrepancy is clearly unsustainable in the long term.

US vs Japan 10-year yields (source: Capital Economics)
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