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June 30, 2022

US yields, commodity disinflation and an exchange rate model for the Japanese yen

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Julius Probst
Arnaud Lieugaut
Patrick Malm
Karl-Philip Nilsson
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Nominal US yields

As inflation spurs central banks to raise interest rates, it is interesting to see how high we can still go compared to previous decades. 

Our first chart shows the evolution of US 10-year yields with decennial averages. The nominal rate peaked in the early 1980s when the Federal Reserve kicked off a series of sharp rate hikes to bring down ultra-high inflation. Since then, a prolonged period of disinflation has led yields to decline continuously – from more than 10% in the 1980s to just over to 2% following the 2008 financial crisis.


Real US yields

Inflation-adjusted yields also fluctuated wildly over the same period – spiking at almost 10% in the 1980s before slipping to a low of -2.4% in the last couple of years. Empirical and theoretical studies have attributed the decline in real rates to a range of factors including adverse demographics, low productivity growth, falling price of investment goods and rising inequality and monopolisation, as noted by former US Treasury Secretary Larry Summers in his secular stagnation hypothesis. 


Business confidence and earnings revisions

Business confidence takes a hit when earnings are revised down. This next chart shows the extent of that correlation. Given the current plunge in expected earnings – towards levels last seen at the start of the pandemic – we can expect a huge drop in business confidence in coming months. 


Commodity price disinflation

After surging to near historic highs at the start of the year, commodity prices have finally settled as demand weakens amid a global and Chinese economic slowdown. This chart shows the trajectory of commodity prices this year against previous years. 


Commodities drawdowns

The next chart shows drawdowns across commodity classes. Industrial metals and agricultural products have fallen by the most from this year’s peak while energy has fallen by the least. Given the decline in overall commodity prices, we can expect some disinflationary pressures on prices in the months ahead.


Cotton prices

Commodity prices are volatile and prone to overshooting. The correction for cotton has been particularly striking, with the price dropping by more than 20% over the last couple of weeks. 


Chinese exports vs US inventories

US manufacturers rely heavily on China for materials and the following chart displays that interdependence. It compares US factory inventories and Chinese exports five months earlier. Inventories often serve as a good indicator of the business cycle, with more goods in stock during periods of economic growth.

The following chart shows that Chinese exports have been declining. In line with that, US inventories will most likely fall if the US economy starts to contract.


Yen exchange rate: fair value model

The following graph shows the value of adding high-frequency indicators to financial variables when modelling exchange rates. 

We created a fair-value model for the nominal broad Japanese exchange rate using the following variables:

  • The Citi Surprise Index 
  • Terms of Trade Index for Japan 
  • The global Citi Macro risk index 
  • The spread between 2-year and 10-year yields for Japanese government bonds
  • The OECD weekly economic tracker

The OECD economic tracker uses Google trends data to estimate economic activity at a much higher frequency than traditional macro indicators. This indicator significantly improves the fit of our model, thus showing how high frequency indicators can be a useful addition to forecasting macroeconomic time series like exchange rates.

Our model tracks the Japanese exchange rate fairly well over time, including most of the recent depreciation. As of right now, the Yen is slightly undervalued compared to our fair value exchange rate model.


Germany temperatures

Here’s a graph that proves global warming is real. It shows average temperatures in Germany throughout the year dating back to 1881 – with temperatures this year rising far above historical averages. 


Impact of Roe v Wade ruling on US Congress

Finally, let’s take the temperature of the US political landscape. 

Democrats have been given a boost following the Republican-heavy Supreme Court’s controversial decision to overturn Roe v. Wade. States now have the right to ban abortions. 

Data from online betting market PredictIt show the odds of Democrats dominating the Senate have increased from about 25 cents to 34 cents on the dollar. Their odds of controlling the House of Representatives have also improved marginally, though they remain slim. 

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