‘Real’ Yield-Curve Shows Central Banks Are Almost Done (For Now)

Authored by Simon White, Bloomberg macro strategist,

The inversion of the global real-yield curve confirms central banks are very near the end of their tightening cycles, keeping risk assets in a sweet spot. However, a re-acceleration in inflation would trigger a warning signal for risk assets as central banks came back into play.

The nominal-yield curve hasn’t been of a great deal of use for investors in this cycle. An inversion has historically been a good sign of an downturn, but it shines little light on when that will happen and, crucially, when to take risk off the table.

In an inflationary environment, we can glean more from the real-yield curve.

The global version has recently re-inverted, signaling that central banks have managed to raise short-term real rates back above their longer-term counterparts.

This highlights central banks’ work is mostly done. But a re-acceleration in inflation, which is probably the single biggest endogenous risk facing stocks, is not widely expected.

The real-yield curve is currently being driven by the rapid deceleration in global inflation. Even though the Fed et al have slowed the pace of their hikes, or are about to, real conditions continue to tighten rapidly.

That is not impinging on the risk rally for now, as the dynamics of the flattening real-yield curve are such that it is boosting excess liquidity via a weaker dollar.

But a return of inflation which, based on building stimulus in China and the nascent rally in oil, could come as early as the end of the year, would likely mark a turn back down in excess liquidity and the prospect of yet higher rates, leaving equities on much thinner ground.