Regular readers of this blog know that I track the break-even TIPS spread to follow changes in inflation expectations. Doing so also provides an implicit (and imperfect) estimate of changes in the real interest rate. (For an explanation of why the break-even TIPS spread is an imperfect estimate of inflation expectations and the real interest rate, see the Cleveland Federal Reserve Bank website.) Since early in May, the data show a fairly striking anomaly in real interest rates: real interest rates over a 5-year time horizon have been rising (though still negative) while real interest rates over a 10-year horizon have been falling.
Why is this anomalous? Because real interest rates at the 5-year and 10-year time horizons are generally closely correlated. The chart below shows fluctuations in real interest rates at constant 5- and 10-year maturities since the beginning of 2012. The two lines track each other closely until the beginning of May when the 5-year real interest rate begins to rise while the 10-year real interest rate continues to fall. The coefficient between the 5-year and 10-year real interest rates from January 3 to May 24 is slightly over .8. From January 3 to May 3, the correlation coefficient is almost .86; the correlation coefficient since May 3 is -.72.
I have no explanation for this anomaly. Anybody out there like to take a crack at it?
UPDATE: It just occurred to me that the increase in short term real rates is reflecting a liquidity premium associated with an increasing perceived likelihood of a financial crisis associated with a breakdown of the euro. Not a very happy thought as I prepare to call it a night.