Dresdner brings us some good central bank news. Here are the charts.
That’s the 10-year nominal swap rate (x-axis) vs the 10-year IL swap rate (y-axis) in the US and Eurozone. Inflation-linked swaps have risen considerably of late, which was one of the main sources of the yield rise in US Treasuries and prevented Eurozone yields from declining further. Anyway, as Dresdner note:
Usually, what one finds and has to expect is that there is a distinct co-movement: nominal yields and inflation expectations rise and fall in tandem, which seems self-explanatory. However, two things are noteworthy. First, in the period after the collapse of Lehman Brothers, the slope of the regression lines became significantly more downwards sloping representing the implosion of inflation expectations and the increased grip inflation expectations had on nominal yields. Furthermore, the very latest episode, depicted by the light green cloud in the charts, is also noteworthy. This represents the data since December last year, i.e. since inflation expectations started to rise again. As can be seen on these charts, they represent a return to a more normal trajectory in the US (left) and even a genuine break with the usual pattern in the Eurozone (right), where no distinct co-movement can be detected any longer.
You can see a similar outcome in nominal rates (x-axis again) vs real rates (y-axis).
Focussing on the US in the left hand chart first, shows that while for most of 2008 the Fed succeeded in lowering real interest rates, the implosion of inflation expectations after Lehman’s collapse drove real rates on a distinctly higher path (black dots). Lower real rates, however, are part and parcel of what the Fed, the ECB and other central banks around the world try to achieve in order to aid the real economy. Higher real rates are counterproductive and will hurt an already ailing economy further. From this perspective, it is no surprise that central banks massively increased their efforts to counterbalance the inflation expectations’ implosion since.
To give the latest developments a positive spin: the recent increase in inflation expectations can thus be interpreted as a sign of the central banks’ credibility to avert a fully fledged deflation spiral. It also shows that central banks still have the ability to influence real rates in the economy.
Hooray central banks?! Long live, err, QE?!
Related links:
Fed capitulates, the central bank is broken – FT Alphaville
Volcker: Not cheering for ‘a little inflation’ – WSJ Real Time Economics