How Real Yields Help Paint the Volatility Picture

Real yields are an important barometer of monetary conditions within the economy. Chief Investment Strategist John Lynch explains, “Indications of higher levels of growth led to a sharp rise in real yields (yields adjusted for inflation) in early 2018. While real yields have rolled over recently, they continue to be a solid gauge of the true borrowing costs for companies, with significant implications for the direction of stock and bond markets alike.”

Rising real yields can lead to higher borrowing costs and tighter financial conditions, which can be a headwind for risk assets. However, over the past two months real yields have slowly moved lower after spiking earlier this year, a welcome development for equity markets.

As our Chart of the Day shows, short-term real yields have risen faster than long-term, leading to a convergence of various maturities. One of the implications of this has been a flattening of the yield curve. Year to date and throughout 2017, the Treasury yield curve has been flattening. An inverted yield curve has historically been a consistent precursor to economic recessions; though as we discussed in a recent blog post, we don’t believe an inversion is imminent. Furthermore, the lag time between when the yield curve inverts and the economy enters a recession has averaged nearly two years over the last five economic cycles. For more on real yields, please see this week’s Bond Market Perspectives. Our Weekly Economic Commentary also gives more details on our views on inflation, a key input to calculating real yields.

 

 

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Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.

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