Nominal incentive, real problem
The difference between real and nominal data has often been the explainer behind why things in the market are not always what they seem. In different circumstances markets may focus upon nominal or real data. Even within the same asset class, even currency, on two different events you can often isolate the market’s seemingly random fixation with nominal over real data or vice versa on two different occasions. Nominal data are the raw numbers collected from the economy or the headline, even seasonally adjusted, statistics behind an asset collated and published. Real data by contrast is that qualified by some other measure, most often inflation. For example, if the interest on a bond is 3.25% but inflation is 9.6%, the nominal rate remains 3.25% but the real rate qualified by inflation is -6.35%. These are the numbers implied by today’s UK 2-year Gilt yield versus the last level of inflation read by the ONS year-on-year for October.
All around the world, rates seem to be rising with very few national exceptions. Despite that, real rates continue to largely still be deeply negative. The reason for that is inflation and inflation expectations more importantly continue to realise and be projected above those of interest rates at the governmental and central bank level alike. Whilst nominal rates remain high and continue to provide a source of risk to consumers and business, in real terms, interest rate rises still under-pace the rate at which the value of money in many nations is eroding via inflation. So far this year it’s fair to say that nominal interest rates and nominal inflation rates have played their own independent roles on currencies. I say this because national currency paths have born little resemblance to the path most domestic real interest rates have taken. Instead, currencies have reacted violently to both inflation data releases and interest rate decisions pricing on the back of the nominal, not real data.
As alluded to above, there have been some exceptions to the focus on respective nominal data. The South African Reserve Bank last week rose rates by 75-basis points to a lofty 7%. The decision was initially seen to provide some, albeit limited, support to the Rand which has been struggling to find support for some time now. This takes domestic SA rates to their highest level since 2009. The market chatter following the decision was so what, 7% in the face of record high domestic inflation will do little to attract investors to domestic South African debt and other such interest-bearing instruments. This was a very deliberate appeal to real over nominal interest rates with ZAR continuing its decline in the sessions following the decision despite a broader environment of USD weakness.
Discussion and Analysis by Charles Porter
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