Tuesday, March 13, 2012

Insane Interest Rates - Countries With 10 Year Bond Yields Lower Than Their Rate of Inflation

The Fed warned today that "inflation could rise temporarily because of the recent increase in oil and gasoline  prices." Given the likelihood of inflation increasing, it seems insane that the interest rate premium for 10 year U.S Treasuries is below the level of inflation. It is straight out of economics 101 that bond pricing includes
An inflation premium added to compensate for the expected loss of purchasing power;
thus, it is obvious that the U.S. bond market is being artificially manipulated to keep interest rates low. While the interest on the 10 Year Treasury did rise a bit today to 2.077% , the rate is still well below the 2.9% rate of inflation in the U.S.

However, as shown in the chart below, the U.S is just one of a number of countries with interest rates on sovereign debt that is below the rate of inflation, basically featuring negative real rates of return. The market with the most negative real rate of return is Hong Kong at -4.8%. The negative real rate of return in the U.S. is also surpassed by Singapore, the UK, Finland, and Denmark. (For reference, today's rise in the U.S. rate on the 10 year note is not reflected in the chart below)

Given that interest rates on sovereign debt is likely to revert back to levels above the rate of inflation at some point, and the world could be in for a nasty bout of inflation due to higher oil prices and money printing by central banks, it seem unlikely that the 10 year notes of the countries listed above will turn out to be good long term investments.

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