September 10, 2019
Real rates (yields minus expected inflation) crossed into negative territory last week, garnering attention from the financial press as an additional signal of an economy at risk.
But, as shown in LPL Research’s Chart of the day, Real Yields Have Been Here Before, the message from real yields may be more benign. While real yields could be a warning of a slowing economy and some added economic stress, they have not acted as a reliable recession signal for the current cycle, and they were above 2% heading into the 2008–09 recession. (Real yields are estimated by the yield on 10-year Treasury Inflation-Protected Securities (TIPS).
Prior forays into negative territory during this cycle (in 2011, 2012, 2013, and 2016) have accompanied signs of slowing, but have also reflected the broader interest rate environment. Slower global growth, increasingly accommodative central banks, and some flight to safety due to trade uncertainty have all conspired to push rates lower.
The expected inflation rate implied by 10-year TIPS sits at about 1.5%, low historically but still higher than the cycle low and well above the near 0% hit in the heart of the last recession. Slower growth has minimized inflationary pressure, but over the last three months we have seen a modest pickup in inflation and wages.
“Negative real rates have become a new talking point for recession risk, but it’s important to maintain perspective,” noted LPL Financial Chief Investment Strategist John Lynch. “They are largely another reflection of the lower global rate environment accompanied by more modest growth expectations. While growth has slowed, the economic numbers lately have largely been in line with more modest expectations, confirming the likely continuation of the economic expansion.”
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