Inflation-protected Treasury securities trading with negative interest rates

Investors bought inflation-protected Treasury securities at a negative interest rate for the first time on Thursday, demonstrating the depth of concerns that Federal Reserve efforts to stimulate the economy could lead to higher inflation in the future.

The $15 billion in Treasury inflation protected securities, or Tips, were sold at a negative yield of about 0.046 per cent. Investors could still make money on their holdings because the principal of such securities increases if inflation rises.

Bill O'Donnell, strategist at RBS Securities, said that investors were accepting "a short-term cost for a potential long-term gain." Treasury securities of all kinds are finding favour as a haven as investors flee the market turmoil in the eurozone.

Investors are turning to Tips as the real returns on fixed-rate Treasuries also have turned negative, meaning the yields are less than the current rate of inflation.

Investors are buying 10-year Treasury notes with a yield of 1.99 per cent. Meanwhile, consumer price data released on Thursday showed that US core inflation, which excludes food and energy, for the year ending in December, advanced 2.2 per cent, its fastest pace of growth in four years. The consumer price index was flat for the second successive month.

The low yields on Treasury securities reflect the impact of Federal Reserve's Operation Twist programme, under which it buys longer-dated bonds, with the hope of pushing down long-term interest rates and thereby stimulating economic growth. US jobless claims dropped by 50,000 to 352,000 in the week ending January 14, the lowest level since April 2008, the Labour Department said.

"The big gorilla in the room is the Fed," Mr O'Donnell said. "They are buying up a lot of debt."

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"Meanwhile, consumer price data released on Thursday showed that US core inflation, which excludes food and energy, for the year ending in December, advanced 2.2 per cent, its fastest pace of growth in four years"

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KMS said:

Understood, but which rules do you really think we should see as the truth?

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There's one indicator that clearly signals we're still in the bull market – and further, that we can expect prices to continue to rise. That indicator is negative real interest rates.

The real interest rate is simply the nominal rate minus inflation. For example, if you earn 4% on an interest-bearing investment and inflation is 2%, your real return is +2%. Conversely, if your investment earns 1% but inflation is 3%, your real rate is -2%.

This calculation is the same regardless of how high either rate may be: a 15% interest rate and 13% inflation still nets you 2%. This is why high interest rates are not necessarily negative for gold; it's the real rate that impacts what gold will ultimately do.

What History Tells Us

The chart below calculates the real interest rate by extracting annualized inflation from the 10-year Treasury nominal rate. Gray highlighted areas are the periods when the real interest rate was below zero, and as you can see, this is when gold has performed well.



Gold climbs when real interest rates are low or falling, while high or rising real rates negatively impact it. This pattern was true in the 1970s and it's true today.

A closer study of this chart tells us there's actually a critical number for real rates that seem to have the most impact on gold. Take a look at how gold performs when real rates are at 2% or below.


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The following extract from Charles Gave's (of GaveKal ) latest letter to clients is a must read for all, especially for the central planning members of the FOMC. The punchline is this statement which is so simple and obvious, it is no wonder virtually noone in control has figured it out yet: "One Cannot Operate A Capitalist System If The State Can Borrow At A Negative Cost."
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