I just finished reading this brilliant article in Barron's. I suggest that everyone takes a few minutes and take a look at it. Here are some highlights:
"Against the backdrop of this uncharacteristic criticism of the U.S. central bank—and equally uncharacteristic defensiveness on the part of the Fed—the bond market had been in virtual freefall. The sharp, nearly-half-point rise in yields translated into steep price losses of 6% for the iShares Barclays 20+ Year Treasury Bond exchange traded fund (NYSEArca: TLT - News), a popular way to participate in the long end of the market. That would equal to nearly a 700-point drop in the Dow Jones Industrial Average, or 200 points more than the Blue Chip gauge's actual decline from its peak only a week and a half ago.
Yet, for all the inflation hysteria provoked by QE2, the bond market's severe back-up in the past couple of weeks reflected something else all together—a leap in "real" interest rates, that is, the level after deducting expected inflation. This perceptive observation comes from James O'Sullivan, chief economist at MF Global.
The real yield comes from the 10-year Treasury Inflation Protected Securities yield, which has risen even faster than the nominal note's yield. The difference between the TIP and the nominal yield is the "break-even" inflation forecast derived from the market, and that's actually rolled over as the rhetoric about the Fed's policy has heated up."
After reading this I decided to do a little research to confirm that "real" rates have indeed been steadily increasing faster than treasuries.
I was able to pull the Novemeber data right from the US Treasury's site:
Date 5 yr 7 yr 10 yr 20 yr 30 yr
11/01/10 -0.34% 0.02% 0.49% 1.23% 1.40%
11/02/10 -0.34% 0.02% 0.49% 1.18% 1.35%
11/03/10 -0.40% 0.00% 0.50% 1.22% 1.43%
11/04/10 -0.48% -0.07% 0.44% 1.20% 1.47%
11/05/10 -0.47% -0.05% 0.48% 1.26% 1.52%
11/08/10 -0.45% -0.04% 0.48% 1.26% 1.52%
11/09/10 -0.31% 0.07% 0.58% 1.40% 1.62%
11/10/10 -0.37% 0.04% 0.56% 1.35% 1.58%
11/11/10 NaN% NaN% NaN% N/A N/A
11/12/10 -0.22% 0.19% 0.71% 1.47% 1.66%
11/15/10 -0.06% 0.34% 0.87% 1.68% 1.79%
11/16/10 0.00% 0.36% 0.87% 1.66% 1.75%
11/17/10 -0.04% 0.32% 0.84% 1.67% 1.76%
11/18/10 -0.06% 0.31% 0.83% 1.64% 1.73% "
As you can see above, "real" rates have indeed risen sharply since the Fed initiated QE2.
This tells us that bond market is indeed beginning to price in inflation which is why the Fed is starting to take so much heat.
Of course Bernanke and the Fed will get on bubblevision and tell all of us that deflation is the larger fear and they must QE in order to keep rates low. The bond market obviously thinks this is utter bull****.
Treasuries rallied hard on the sell off on Tuesday which relieved many bond investors. However, as you can see above, the "real" rates didn't. They merely paused for the last couple days, and the trend is headed in only one direction.......... Higher!
This disconnection between "real" rates and treasuries will not last long, and it tells me that the bond vigilantes are still busy behind the scenes pushing yields higher.
Keep your eye on this moving forward. "Real" interest rates tell you what the bond market REALLY thinks in regards to inflation, and this recent trend suggests that they are starting to get very nervous about it.