Real Yields Are the Market's Big Lie

When you have radiotherapy for prostate cancer, you need to drink a lot of water so that your bladder is “comfortably full.” Sitting in the hospital waiting for my treatment with gritted teeth, I was mulling, not for the first time, that the meaning of the word “comfortably” was being stretched beyond the point of breaking when an elderly man turned to me and asked if I was Richard Cookson. I was hugely touched and impressed that my old philosophy tutor had recognized me. It was, after all, almost 40 years since we had last seen each other.

I was also a bit ashamed that he had recognized me first. He is one of the most admirable people I have ever met. In tutorials he sat listening intently to carefully constructed arguments (or so I hoped) with a sort of twinkly beneficence before demolishing them with the merest question. To his surprise, I said philosophy was the most useful subject I had studied because it had taught me to question and think.

Many of the things that people think and write about in financial markets don’t stand up to much scrutiny. A subject that has been exercising central bankers and markets of late is forward-looking measures of real yields. Much as I have written about them myself, I am increasingly of the opinion that they are about as meaningful as that word “comfortably.”

Real yields represent the difference between the rate of inflation and interest rates. Positive real yields occur when interest rates are higher than inflation and negative real yields are when the opposite happens. Real yields are reasonably simple to measure after the fact (what economists call ex post). You look at interest rates and inflation over a certain period and see if the former has compensated you for the latter. Measures of current real rates are a variation on this: You compare the lagging inflation rate with current interest rates. Hence, despite central bank rate increases, the latest by the European Central Bank last week, current real rates are still massively negative everywhere because inflation is so much higher than interest rates.