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Re: Brewer et al- Interest Rate Data?
Old 05-20-2006, 09:28 PM   #21
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Re: Brewer et al- Interest Rate Data?

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Originally Posted by ats5g
It's interesting that people seem to be focusing on the fluctuation in value of their assets, but aren't looking at the fluctuation in value of their liabilities.

While the increase in real yields has been decreasing the value of the TIPS [which is just the present value of the income stream from the TIPS], it has also been decreasing the present value of our future real liabilities.

So, if I own TIPS the affect of rising real interest rates can be offsetting.

- Alec
Unless i misunderstand, few retired people have much in the way of fixed liabilities. Maybe a mortgage, but many or most ry to pay it off.

Ha
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Re: Brewer et al- Interest Rate Data?
Old 05-20-2006, 09:41 PM   #22
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Re: Brewer et al- Interest Rate Data?

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Originally Posted by HaHa
Unless i misunderstand, few retired people have much in the way of fixed liabilities. Maybe a mortgage, but many or most ry to pay it off.

Ha
Hi Ha,

I was referring more to all of our future outlays/spending as future liabilities. For example, the present value of my gas bill payment for october 2010 falls as real interest rates rise [b/c the interest rate i'm using for discounting rises].

-Alec
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Re: Brewer et al- Interest Rate Data?
Old 05-20-2006, 10:26 PM   #23
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Re: Brewer et al- Interest Rate Data?

Alec, you're making my brain hurt. Thanks!
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Re: Brewer et al- Interest Rate Data?
Old 05-20-2006, 10:41 PM   #24
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Re: Brewer et al- Interest Rate Data?

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Originally Posted by lazyday

-Interesting about the Tips yield dropping when inflation dropped. So, is there a theoretical explanatory guess? It's not like the disinflation was caused by economic decline, which might be expected to drive real rates down.
SWAG alert! SWAG alert!
The following message is merely an exercise in natural deduction.

I would suggest that the relationship between real/inflation rates could be viewed as the real rate not being overwhelming or underwhelmed by the inflation rate.

For instance..if inflation were 8-9%, how would you feel about getting a 1% real rate? Pretty crappy, right, since it's underwhelmed by the inflation coupon?

Conversely, if inflation is expected to be a miniscule 2%, then a real rate of 6% would overwhelm the inflation rate, and would weigh out the inflation rate too much.

You might look at the early I-bonds/TIPs with real yields of 3%-4 1/4% as being abnormally high due to both the stock market excesses at the time, as well as the new nature of the product not capturing as wide of an interest at the time.

I can't really think of any good analogy...perhaps think about cars. You wouldn't expect to see a 6.0L engine in a honda, and you wouldn't expect to see a Yugo engine in a Bentley. Or, consider real estate agent comissions - on a 20,000 house, you might agree to more than the 'standard' 6%, since 6% is merely $1,200 in total comissions. Conversely, on a $10 million estate, you could negotiate a much lower rate, since even 5% is still a hefty $250,000 in total comissions.

(note: Yes, I know that the whole real estate comission structure is finally opening up to some competition, and is based on an oligarchy of real estate firms keeping the price artificially high. I am merely using it as the only example I could think of).
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Re: Brewer et al- Interest Rate Data?
Old 05-21-2006, 12:02 AM   #25
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Re: Brewer et al- Interest Rate Data?

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Originally Posted by Peter76
For instance..if inflation were 8-9%, how would you feel about getting a 1% real rate? Pretty crappy, right, since it's underwhelmed by the inflation coupon?
Something like this happened just six months ago.* *i-bonds real rate was around 1%, annualized inflation was around 6%, and people *loved* that resulting 7% return because it was much higher than any nominal bonds.

That is the secret sauce.* *People weigh investments relative to one another.* *If inflation is held constant, and some other investment looks more attractive than nominal bonds, money will flow out of nominal bonds, and the lower demand will force the real yield back up until equilibrium is reestablished.* * The real yield is all about supply and demand in the bond market.* *(That's my story, and I'm sticking with it!)
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Re: Brewer et al- Interest Rate Data?
Old 05-21-2006, 09:42 AM   #26
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Re: Brewer et al- Interest Rate Data?

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Originally Posted by wab
Something like this happened just six months ago. i-bonds real rate was around 1%, annualized inflation was around 6%, and people *loved* that resulting 7% return because it was much higher than any nominal bonds.

That is the secret sauce. People weigh investments relative to one another. If inflation is held constant, and some other investment looks more attractive than nominal bonds, money will flow out of nominal bonds, and the lower demand will force the real yield back up until equilibrium is reestablished. The real yield is all about supply and demand in the bond market. (That's my story, and I'm sticking with it!)
wab...I'll agree with your comment about the recent 6% spike in CPI. HOWEVER....remember that in the 80s/early 90s, weren't the bond markets largely run by the institutions? Sure, you had some people investing in Treasury Direct, bought a few savings/corporate bonds, etc....but, compared to today, wasn't the bond retail market much smaller and more difficult to get into (in the sense of getting good bid/ask spreads, good information, etc.) for the retail investor?

Today, there are several companies that you can buy corporate bonds direct at auction for a nominal fee, Yahoo! and other sources have information going out the wazoo, and the retail investor has much more access.

My point? I would venture to say that when CPI spiked to 6%, and I-bonds were paying 7%+, you didn't get many corporations/investment bankers lining up to buy them because they were educated enough in interest rates to see the 1% fixed catch. The people lining up to buy the 1%/1.1% fixed + CPI were mainly (I would assume) retail investors in preferred stocks/bonds. Also, most economists knew that the spike was probably temporary, due to Katrina's impact on gas and other prices (although oil has continued its ascent).

Therefore, I would somewhat discount that.

Also, another comment I forgot to add in my original post...when inflation is at 8%, a 'small' change in inflation could be 2-3% (up or down), so your fixed rate would have to be fairly good to still be a reasonable percentage of the overall rate. If "inflation" expectations are for 2%-3% (yes. I know, CPI is flawed), then a 'big' change in inflation would be 1/2%....not too much of a change that would chip away at the fixed portion and overwhelm it. (see Brazil's current real rates. I think their real fixed rates are somewhere around 10-12%. Yes, there's currency risk, but they're selling these to local companies/consumers as well. Their stock market is on a roll, so it'll be interesting to see how their real rate changes as inflation and their market slow down).

Sure, I do agree about the whole "stocks were turning in decent numbers, and there were supply/demand issues with fixed income when put up against equities"...but I would suggest that there could have been some of the other factors at work too.
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Re: Brewer et al- Interest Rate Data?
Old 05-21-2006, 09:51 AM   #27
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Re: Brewer et al- Interest Rate Data?

I suppose if current inflation was 10%, consensus expected future inflation was 10%, and 5 year nominal and TIPS bond yields were 12% and 2%, I'd consider moving some money from TIPS to intermediate or long nominal bonds, for more disinflation/deflation protection, and to speculate on reduced inflation someday.

With current circumstances and yields, I'd rather own TIPS than intermediate nominal bonds, for about the same expected real yield but with much more inflation protection (while inflation is still low) and still a little deflation protection.
I'm also speculating that inflation is more likely than disinflation, but am not counting on that.

Under the 10% scenario above, some people (including institutional investors) might be scared because inflation had gotten so high, it could go much higher, and would like to buy more TIPS to protect against that. So maybe TIPS buyers like them would drive TIPS yield down, while sellers like me would drive TIPS yield up.


> The real yield is all about supply and demand in the bond market.

Hard to argue with that!
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