Central bankers like Janet Yellen and Mario Draghi talk a good talk. Indeed, their lines of argument fuel headlines, which in turn send signals to the market.
But portfolio manager Axel Merk of Merk Investments is warning investors to consider the vested interests at stake and to be guided neither by rhetoric nor by nominal rate policy but rather by real rates.
The headlines du jour concern a divergence between U.S. rates, which are headed up as the Federal Reserve tapers off its bond-buying, interest-rate-suppressing monetary policy, and European rates, which must remain lower longer because of the eurozone’s weaker economy.
European Central Bank chairman Mario Draghi has surprised observers by aggressively justifying the euro’s recent exchange-rate decline.
His talking down the eurozone’s currency, especially at a time when U.S. interest rates are thought to be on an upward trajectory, would tend to have the positive — from Draghi’s point of view — effect of weakening the euro and thereby strengthening Europe’s export sector.
And indeed these expectations, of higher U.S. rates and lower European rates, are reflected in the 2-year swap rates between the dollar and euro, Merk shows.
But the currency funds manager points out that this policy divergence reflects nominal rates. Looking at real rates — calculated after the effect of inflation or deflation — tells a different, actually opposite, story, he says.
One way to view real rates, via tradable investments, is to look at Treasury Inflation Protected Securities, or TIPS. Only a few European countries — Germany, France and Italy — have such securities.
While German bonds have lower real yields than U.S. TIPS, the Italian rates, which Merk suggests are more reflective of the eurozone as a whole, are substantially higher than U.S. rates.
But more to the point, looking at current central bank data, Merk shows that real interest rates in the U.S. are not only lower than in the eurozone, but also that their divergence has been increasing.