Real rates are moving higher together in G-10

While much of the story has been focused on carry trades and nominal interest rates, a focus on real rates should not be missed. The inflation adjusted or real rate is the returns that bond investors should have the most interest. We took the simple approach of using 2-year nominal rates and subtracting the yoy CPI inflation rate. This simple approach, albeit backward looking provides a good estimate of the current real rate. If inflation is more volatile a forward-looking measure would be appropriate.

While there are no surprises in the relative ranking of the real rates relative to nominal rates. The differences between countries tells a story that flows should be starting to change. First, there has been a general rise in real rates around the G10. Second, there has started to be a compression of spreads across countries. With less real spread differentials across the countries, flows will be more sensitive to risk considerations. The signal from higher carry returns may be diminished. Third, the US has improved its relative return position versus a number of countries. While this may not drive the currency in the short-run, dollar declines will have to be associated with other reasons. Granted there are many reasons for a dollar decline, but the real rate may not be a strong contributor. Risk considerations at this juncture may be paramount.