More on the Recent Anomaly in the Real Term Structure of Interest Rates

In a post last week, I pointed out that there was a highly unusual inverse correlation between the 5- and 10-year real interest rates as approximately reflected in constant maturity 5- and 10-year TIPS. (On the meaning of the term “constant maturity” see the very valuable and informative post in J.P. Koning’s excellent blog summarizing discussions in the many blogs that he follows and comments on) about the various blogs Since early May the correlation coefficient between the yields on constant maturity 5- and 10-year TIPS was about -.72 (as of today it’s -.77), while the correlation coefficient between the two yields since the start of 2012 was .86.  It occurred to me after writing the post (I added an update to make the point) that one reason for the inverse correlation might be an increased in the expected likelihood of a financial crisis, in which case real short-term interest rates would rise during the crisis as people expecting to be short of cash bid up real rates trying to get their hands on cash ahead of the crisis, while also selling off assets (either fixed capital or inventories).

This week, I was able to do a little further work, looking at data since 2003, on the correlation between interest rates at the 5- and 10-year time horizons. Since 2003, the correlation between real 5- and 10-year interest rates is about .96. I computed monthly correlations, which are usually over .8 and regularly over .9. Only very rarely was there a (barely) negative monthly correlation, certainly nothing close to the -.77 correlation during the first 30 days of this month. However, as I computed the correlations, I found that a more meaningful measure of the relationship between the 5- and 10-year yields on TIPS is the absolute difference between them. The graph below plots the yields on 5- and 10-year constant maturity TIPS since 2003. The most striking period is clearly in October and November of 2008, when the yield on 5-year TIPS soared above the yield on 10-year TIPS, because of the desperate scramble for liquidity at the height of the financial crisis. A few other periods of financial stress, associated I think with the first signs of the bursting of the housing bubble, were also associated with yields on the 5-year TIPS slightly exceeding the yield on the 10-year TIPS.

A second graph displaying the difference between the yields on the 10-year and the 5-year TIPS is also useful, clearly showing the effect of the spike in short-term real interest rates at the height of the financial crisis.

In this context what is striking about the recent anomaly in the real term structure of interest rates is the steepness with which the difference between the yields on the 10- and the 5-year TIPS has been falling. The drop seems steeper than any but the one that started around October 6, 2008, three weeks after the failure of Lehman Brothers, but the day on which the Fed announced that it would begin paying interest on reserves. By the end of October, the difference between the yields on the 10-year and 5-year TIPS had fallen by over a percentage point. Since May 3, the difference between the yields on the 10-year and 5-year TIPS have fallen 37 basis points, so we are clearly not in a panic. But the signs are disturbing.

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11 Responses to “More on the Recent Anomaly in the Real Term Structure of Interest Rates”


  1. 1 Bob Heine May 31, 2012 at 5:56 am

    I have read your posts about the term structure of real interest rates and have 2 comments: First, and most important, people trade these instruments on a forward basis. Right now, in May, people are accruing “inflation interest” on March CPI (released in April, used in the May calculations for inflation accrual). Gasoline shot up in the first quarter and is declining now so investors and traders are calculating its affect on CPI. Because shorter maturities are more affected by month to month or 3 month change in CPI they are adjusting their inflation accruals accordingly. Again, the same thing happened in 2008, gasoline (and other CPI inputs such as car prices etc.) plunged making future CPI #s flat to down. Again, it affects total return much more strongly in the shorter maturities.

    Also, there was a big liquidity premium for on the run issues in 2008. I remember a 10.25 year issue (T8.875 2/19) being over 60 basis points cheaper than the then current 10yr (T3.75 11/18) with both issues the same duration. Another factor in 2008 was that Lehman (and others) held alot of TIPs for collateral purposes and, with the liquidation, sold them at the market, regardless of price.

    I will grant the change in correlation is unusual (yield curve flattening dramatically in the past few months could be a factor). More disturbing is that 16 year TIPs are yielding 0.0% which I hope isn’t saying there are no investment opportunites in the US (or the west) in the future. It will be very grim news indeed if, 15 or 16 years from now, we look back and congratulate our investment prowess for accepting a 0.0% real yield for that time period. Of course, if it turns out to be a good investment mathematically the US will be hard put to make the maturity payment anyway!

  2. 2 Tas von Gleichen May 31, 2012 at 11:08 am

    This total interest article get’s me more confused than anything else. When I look at the graph that’s when I get it.

  3. 3 David Glasner June 2, 2012 at 9:16 pm

    Bob, Thanks for your informative comments. It helps to have an insider’s view. And, yes, it is scary that the expected real return on investment over 16 years is zero.

    Tas, That why they say that a picture is worth a thousand words.

  4. 4 JP Koning June 6, 2012 at 9:00 am

    David, here is an interesting comment on the inversion in the TIPS curve.

    http://mikeashton.wordpress.com/2012/06/05/inflation-risks-more-balanced-but-not-by-much/

    He has an interesting theory that short term TIPS trade like gasoline futures, since TIPS are indexed to headline inflation. As you move out along the curve, returns are more real-like and less gasoline-like. Gasoline futures prices have plunged since March, from $3.30 to $2.70.

    The question then is why have gasoline prices fallen? There is probably a “real” supply-side component to this decline. The technical revolution in oil & gas exploration (horizontal drilling + multiple stage fracking) has created a massive increase in North American oil and gasoline inventories which is putting downwards pressure on prices.

    Thus the inversion in the TIPS curve could have an unhealthy component due to fears of deflation and a more healthy component linked to the technical advances that have caused huge oil inventories.

  5. 5 David Glasner June 7, 2012 at 7:34 pm

    JP, Thanks for sharing. I see that you are presenting your paper on Adam Smith at the HES meeting in two weeks. I am going to present a paper on Hayek and Sraffa based on a blog post last August or September. Am looking forward to meeting you.

  6. 6 JP Koning June 14, 2012 at 6:31 am

    David, unfortunately I’m going to have to miss HES. Something has come up at the last minute. It would have been nice to meet in person, and I do look forward to reading your paper. Will you post it to your blog?

  7. 7 David Glasner June 14, 2012 at 10:15 am

    Sorry to hear that; I was looking forward to meeting you. I will email you the paper when the current draft is finished. I will not post it on the web until after the conference and perhaps another round of revisions.


  1. 1 Links for 2012-05-31 | FavStocks Trackback on May 31, 2012 at 12:46 am
  2. 2 Links for 2012-05-31-Economic Issue | Coffee At Joe's Trackback on May 31, 2012 at 1:40 pm
  3. 3 Linkfest | Dan Popa Trackback on June 5, 2012 at 7:38 pm
  4. 4 More on Inflation Expectations and Stock Prices « Uneasy Money Trackback on June 6, 2012 at 8:41 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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