Tuesday, November 13, 2018 Market Comment - by Jeff Caughron

Adjusted for inflation expectations, the “real” yield on the 5yr T-Note now calculates to the highest level in over a decade. The nominal yield minus the Fed’s five-year breakeven rate now comes in at .97%, a level not seen since 2007, the last year of the prior cycle expansion.  The same calculation using observed inflation (PCE core, for example) shows a similar trend, but at the highest level in seven years (rather than eleven). Either way, there is substantial value in bond yields today compared to what’s been seen in many years.

Bank managers are also facing an environment where loan pricing has been remarkably constrained even in the face of strong loan demand. This, no doubt, is a testament to more careful underwriting and loan pricing in the face of stiff competition from other lenders. In any case, the economic advantage of taking on more credit risk  by lending money rather than buying securities has fallen off sharply over the last year.

US 5yr T-Note Yield Adjusted for Projected Inflation (Green Line Below): 2001 - Today