Looking at i think 1′.87, and we can bring it up here on the screen to see what it is live. What do you think about the strength? Well, either the strength of sterling or the weakness in the dollar you’re. Quite right matt, it could be a combination of both couldn’t that most people, i think, will recognize that the uk – perhaps rather through luck than judgment, seems to be uh bouncing a bit better than other parts of europe. That may be one of the reasons. I also think that the tail risk of negative rates was pretty much taken off the table a week or so ago, and and that’s helped. If you think about the possible scenarios that might be there for rates in the future, so there’s a few things underpinning that sterling rally: uh i’m, not the fx guy, but but clearly there’s been some some upside surprise in the data uh and in the rate outlook And it’s all relative to the us and europe you’re, not the fx guy, but of course it touches all the um. It touches everything that you deal with. I mean you point out negative rates. Um affects the currencies, and the possibility of that of course affects your world even more seriously. Is it off the table? Is it uh no longer something that the that investors and guilts have to worry about? Well, it’s? Definitely not off the table forever, it’s off the table for now, perhaps for this cycle and that’s, a very important uh thing to point out so i’m glad you’ve gone there.
We have negative real rates at the short maturities of minus 200 in the u.s and europe. Nearly minus 300 in the uk that’s a function of rates being trapped, close to zero projected to be at zero because of forward guidance and qe et cetera, and then, when you get the rising inflation risk premier and some rising inflation expectations, then that pushes the real Yield down it’s the only way it can go. The fact that the real yields are so deeply negative just tells you that markets function, okay with negative rates, it’s just a question of time. Before we get nominal rates going negative uh in some parts of the world. You could see it soon in the u.s by the way market rates, not official rates market rates because of of the of the technicalities in the money market at the moment, there’s just so much uh collateral around and it’s really pushing the yield down actually, as you’ve, Probably seen short dated yields in the us have been going down, whilst there’s been upward pressure elsewhere on the curve, and you don’t think that’s going to cause a problem in the economy in the markets. Well, there’s something interesting happening matt and you can look through through fixed income at things like those short yields going down so much at the moment. The the possibility that you could see market yields going below zero, the the cheapness of uh off the run, bonds versus on the runs uh.
The movements in the bonds versus swaps there’s a bunch of things that are red flags to me and they’re, saying something is cooking in the system and i know risk assets have been only going up, everything’s been going up, but there’s something cooking under the surface. Yeah. Actually um our abigail doolittle, who watches stocks for us in the us uh, had a chart the other day showing that, as we see the yield curve steepen when it uh when it, when it steepens uh more quickly, then you start to see the s p. 500. Um get volatile or maybe even correct, actually here’s the chart. Hillary just brought it up. 1449.. Why is that you think when um, when this is the twos tens? Why do you why? Why is it when the yield curve steepens, it tends to kind of freak out people and risk assets? I guess it depends what kind of steepening it is if it’s benign, then it should be good for some sectors of the stock market. Clearly, it’s good for banks who can can lend at a higher rate and and borrow as a lower one in theory at least the steep yield curve should work for banks. But if it’s, if it’s, fast and disruptive, then it starts to mess up investment plans and and it might start to to disrupt uh some of the assumptions in equities and credit. For example, much of the valuation in the equity market is premised on very low real rates for a very long time now, as you can see from the yield curve, the real rates are low at the long end and they haven’t really moved.
The only action is at the front end where they’ve been diving lower so so to to me there’s a bit of a force signal, uh being given by the bomb market um. Maybe the the yield curve. Steepening is mainly a function of inflation risk premium. You should know this: it isn’t actual inflation it’s the fact that the oil price went up compared to last year and the risk premier around future inflation has zoomed up by the way the risk premier is a measure of uncertainty. That means it could go up or down. We just don’t know but it’s not the same thing as actual inflation. So what the yield curve is telling you is, it doesn’t know it’s unsure it’s possible that the huge policy mix experiment might start to have some impact. It could be disruptive uh that’s. How i read it anyway. So is that kind of that kind of uncertainty? When you say something’s, cooking right, something’s happening something’s bubbling under the surface um. Do you have an idea as to what that could be or is? Do you have that same kind of uncertainty as well? Well, i’ve written about it. I called it beneath the beneath the surface and that’s the bubbling under the cooking thing it and it refers to what’s going on with short dated real yields. They’Ve been going down to deeply negative levels, so u.s short dated real yields are minus 200 when they were plus 100 only a year and a half ago, that’s.
Quite some move in fact they’re minus 200 in europe as well. Does that mean it’s stimulative is that is that a reason to take risk, or is that the sign of something something else you see? I i think we could be seeing the latter stages of some speculative activity and again think about what’s happening in the alternatives in bitcoin and what’s happened with reddit and and the fact that everyone’s looking over their shoulder just checking what’s going on here it’s. It seems to me that that something is happening by definition you don’t know until afterwards, but there’s a lot of red flags in the bond market. I, when i went through the list just now, look at the bond slot spreads. Look at the on the right off the run. Look at the curve look at the elongated real yield compared to the short dated lots of stuff happening uh. Meanwhile, the bond market has repriced so that yields have gone back to where they were pre pandemic. That’S government funds – credit is still tight and equities are flying. So you can take your pick from that.