Monday, June 13, 2016

Short-term traders should not fear equilibrium real rate

The heated discussions on what is the equilibrium real rate of interest may seem of limited interest to short-term traders. It should not be. There is significant agreement that the equilibrium rate has fallen because of a number of long-term factors. Most of these drivers will not change in the short-run.  Any money manager or investors worried about bond performance in 2016 should rethink their view in light of the long-term equilibrium rate.

Demographics, for example,  may tell us an interesting story for why real rates have declined over the last few decades but many may think this information may not help over the next 90 days. This view may be misplaced. The equilibrium rate helps set the distribution or span of  rates. A lower equilibrium rate will bound the potential range regardless of what may happen in the short-run.

The equilibrium real rate is low and will stay low and investors have to incorporate this view in their thinking. A current fear of a large rate increase is unnecessary. The opportunity is still for lower rates especially given the pressure from the EU and Japan.

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