Sometimes it’s best to let the numbers do the talking. Without further adieu, we offer the following statistical recap on the 10-year Treasury yield, its counterpart in the 10-year real yield a.k.a. TIPS, and the spread between the two.
As always, minds will differ as to the implications of the above chart, and so what follows is your editor’s view, which may or may not be relevant for the foreseeable future. That caveat aside, consider the persistent decline in 10-year yields in both nominal and real measures since last July. On this point, at least, all can agree: the bond market’s become increasingly giddy, bidding up the price of government debt, which, of course, results in pushing yields down.
The 10-year Treasury’s nominal yield was comfortably north of 5.0% midway in 2007; at last night’s close it was 3.68%.
For the 10-year TIPS, a similar story has been unfolding, albeit at lower rates, which is typical for real relative to nominal. Back in June 2007, the 10-year TIPS yield was as high as 2.83% at one point; now it’s 1.44%.
Meanwhile, consider the spread between yields on nominal Treasuries and TIPs, a gap that’s considered a measure (albeit not the only one or necessarily an infallible one) of Mr. Market’s inflation outlook. As such, the two Treasury markets are priced in anticipation of inflation of 2.24%, defined as the current 10-year yield (3.68%) less the current 10-year TIPS yield (1.44%). Oh, and by the way, the spread has remained fairly constant for the past six months or so, as the chart above reminds. The implication: the inflation outlook hasn’t change much, if at all since last summer.
Ah, but here’s where it gets interesting, or frightening, depending on your perspective. The latest Consumer Price Index numbers, which are widely accepted (tolerated?) as the U.S. inflation rate reveals prices rising by 4.1% for 2007. That’s far above the 2.24% inflation rate implied by the spread in nominal and real Treasury yields.