TMC #1! Mainstream financial commentators are overlooking the most important labor market indicator and drawing misleading conclusions about what Fed tapering really means.
Hey Alfonso - interesting thoughts! Can I ask which Bloomberg tickers you use to construct the "Observed real rates minus r-star" plot, please? Can't bring it up quite the same to play about with...thanks.
Ehi Matt. I use GTII10 Govt for 10y US real yields and for r* just type ''Laubach Williams R Star'' in the BBG bar and you should find it. It's not updated since early 2020 I think, but in any case I also have my own prop model for r* that I use.
Alfonso could u explain this part regarding tapering:
less policy accommodation = drop in inflation expectations and higher nominal rates required to own bonds
i understand that less policy accommodation results in a drop in inflation expectations. But why are higher nominal rates required to own bonds?
if there's a drop in inflation expectations, shouldn't investors require lower nominal rates to own bonds, considering that inflation will not erode the interest rate yield of bonds as much?
Sure, Tom. When policy accommodation gets withdrawn, investors generally require a higher ''safety buffer'' to own long-term bonds - also known as term premium. Less policy accommodation also coincides with lower implied inflation expectations at a time when required term premium is higher, hence resulting in higher real rates (for the wrong reasons => drop in risk assets).
I think you may want to differentiate between risk free bonds and risky bonds (corporate bonds). I can imagine investors will demand higher premium for holding risky bonds, but with less policy accommodation and lower growth, I would imagine demand for risk free bonds would soar, hence lower risk free nominal rates.
Hi, Alf. I am enjoying your articles and learning a lot. Thank you for creating this substack. I am not a professional in your industry or banker. I am just a regular person who is trying hard to understand this stuff. I note that the St. Louis Fed suspended reporting on r*. I don’t know. Maybe they were looking down the road and decided that, if they ostensibly ignored r* for awhile, they would have plausible deniability in the future when the economy falls apart. Is there some other metric we could use since r* is no longer available? If this is something you discussed after you wrote this particular article, then I am sure I will come across it as I continue to read the rest of your articles. Best regards.
Hey Alfonso - interesting thoughts! Can I ask which Bloomberg tickers you use to construct the "Observed real rates minus r-star" plot, please? Can't bring it up quite the same to play about with...thanks.
Ehi Matt. I use GTII10 Govt for 10y US real yields and for r* just type ''Laubach Williams R Star'' in the BBG bar and you should find it. It's not updated since early 2020 I think, but in any case I also have my own prop model for r* that I use.
Great - I appreciate the colour on this, thanks.
Alfonso could u explain this part regarding tapering:
less policy accommodation = drop in inflation expectations and higher nominal rates required to own bonds
i understand that less policy accommodation results in a drop in inflation expectations. But why are higher nominal rates required to own bonds?
if there's a drop in inflation expectations, shouldn't investors require lower nominal rates to own bonds, considering that inflation will not erode the interest rate yield of bonds as much?
Sure, Tom. When policy accommodation gets withdrawn, investors generally require a higher ''safety buffer'' to own long-term bonds - also known as term premium. Less policy accommodation also coincides with lower implied inflation expectations at a time when required term premium is higher, hence resulting in higher real rates (for the wrong reasons => drop in risk assets).
I think you may want to differentiate between risk free bonds and risky bonds (corporate bonds). I can imagine investors will demand higher premium for holding risky bonds, but with less policy accommodation and lower growth, I would imagine demand for risk free bonds would soar, hence lower risk free nominal rates.
Very good article and focus on a number too often overlooked! Well done, Alfonso!
Yes, labor supply growth > participation rate > U6 > U3 in terms of hierarchy in my opinion. And we only hear about U3.
Hi, Alf. I am enjoying your articles and learning a lot. Thank you for creating this substack. I am not a professional in your industry or banker. I am just a regular person who is trying hard to understand this stuff. I note that the St. Louis Fed suspended reporting on r*. I don’t know. Maybe they were looking down the road and decided that, if they ostensibly ignored r* for awhile, they would have plausible deniability in the future when the economy falls apart. Is there some other metric we could use since r* is no longer available? If this is something you discussed after you wrote this particular article, then I am sure I will come across it as I continue to read the rest of your articles. Best regards.
Excellent presentation of what happens at the front stage and what stays hidden at the back stage. Helps long term allocation investing .
Thanks, Ioannis. Stay tuned for the next piece where I'll talk more about asset allocation.
I am thanking you Alfonso. Looking forward to read about asset allocation.
Nice one, thanks for sharing!
Thanks, Vic!