Just after I wrote my previous post about the recent decoupling of inflation expectations and the S&P 500, it was reported that the breakeven 10-year TIPS spread at the close of trading on Friday was a paltry 0.03%. But that 0.03% was a remarkable milestone, because the last time that 10-year TIPS spread closed above zero, was January 24, 2012, almost 18 months ago. At the close of trading on Thursday, the TIPS spread had been -0.05%. Friday’s jump of 8 basis points in the TIPS spread followed the announcement that 175,000 new jobs had been added in the US in May, more than expected given fears that continued fiscal tightening is now acting as a drag on the recovery. The S&P 500 rose by 18 points, over 1%, suggesting that the announcement was taken as a sign that net corporate cash flows would exceed previous expectations, which is how stock prices could rise despite being discounted at rising real rates.
And again today, real rates again rose by another 8%. However, the S&P 500 was essentially unchanged, which suggests that there was a slight further improvement in expectations of future net cash flows, but that these improvements were exactly offset by the increase in real discount rates. All in all, the expectational news for the past two business days seems mildly favorable. However, inflation expectations are continuing on their recent downward trend, so the prospect of a premature withdrawal from the Fed’s half-hearted QE program seems to be a cause for concern.
Say, it ain’t so, Ben!
Uneasy Money 
Real mortgage rates:
http://research.stlouisfed.org/fred2/graph/fredgraph.pdf?&chart_type=line&graph_id=&category_id=&recession_bars=On&width=630&height=378&bgcolor=%23b3cde7&graph_bgcolor=%23ffffff&txtcolor=%23000000&ts=8&preserve_ratio=true&fo=ve&id=MORTG_REABSHNO&transformation=lin_pc1&scale=Left&range=Custom&cosd=1960-05-01&coed=2013-05-01&line_color=%230000ff&link_values=&mark_type=NONE&mw=4&line_style=Solid&lw=1&vintage_date=2013-06-10_2013-06-10&revision_date=2013-06-10_2013-06-10&mma=0&nd=_&ost=&oet=&fml=a-b&fq=Quarterly&fam=avg&fgst=lin
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David,
I think that we are seeing a positive supply shock here – commodity prices are declining. That should push down inflation expectations and with the fed more or less targeting NGDP growth that should push up real GDP and hence, real bond yields.
Or said, in another way – lower inflation opens the door for pushing the the AD curve to the right without jeopardizing the “inflation target”. That is good news for stocks and should push up real yields.
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Did you mean to say TIPS spread or TIPS yield in the first paragraph?
The 10 year TIPS spread (nominal – TIPS) is currently 2.15%. The 10 year TIPS yield is currently 0.06%.
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As hinted at by Glasner, the market is reacting to uncertainty about the Fed. The Fed has shown no resolve, no firm direction, and indeed has had a stop-and-go, maybe-maybe-not QE program.
Add on FOMC members pompously pettifogging of the perils of inflation.
This has created a great deal of uncertainly. Who knows what the Fed will do? For some reason, this outrage is tolerated.
The Fed needs to make clear it will stick with QE for a long time, as in years, or until eight straight quarters of 3 percent real growth are obtained, or something to that effect.
The market fears the Fed will buckle whenever inflation reaches 1.75 percent. And the market is probably right.
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