Saturday, November 22, 2008

Treasuries as Negative Beta Assets?

As the above graph illustrates, the relationship between Treasury securities and inflation-indexed bonds has been very odd of late. The blue line is the yield on 5-year nominal Treasuries. The red line is the yield on 5-year inflation-indexed Treasuries.

My colleague Robert Barro suggests a hypothesis:


Had an interesting discussion with [xxxxx] about the odd recent behavior of indexed-bond rates. The basic idea is that, in the present environment, nominal Treasuries have a negative beta. If we go into Depression, the expectation is that this will be accompanied by substantial deflation, so that Treasuries will do well in real terms. In contrast, the typical pattern is different--perhaps bad times are usually accompanied by high inflation or at least average inflation. Therefore, especially at the shorter end, the relation between indexed and conventional Treasuries has shifted--the real rate on indexed bonds now has to be well above the expected real rate on nominal bonds. This observation also means, particularly at the shorter end, that the spread provides little information about expected inflation.

Of course, there are also liquidity stories, concerning the thinness of indexed bond markets. But I don't think this would apply particularly to shorter maturities. And the market has always been relatively thin.


Thanks, Robert.