Here's a blog I wrote on 4 July 2005, when the UK real yield was at 1.39%:
Independence Day and it’s very quiet in the in the inflation and interest rate markets, affording some respite after last week’s rally, the real yield closing up today at 1.39%. Frankly, there’s not much else to say so, instead, here’s some quantum physics, as it applies to the real yield.
In 1935, Ervin Schrödinger came up with an intriguing experiment. Stick a cat in a box with a radioactive time bomb and a vial of hydrochloric acid and close the lid. After one hour, due to conditions in the box (which are either good or bad –we don’t know if the bomb has gone off until we look) the cat will be either alive or dead or both (the Psi equation allows for this possibility). But, and here’s the rub, by simply lifting the lid to find out, we disturb the experiment and affect the result. If the cat lives or dies it does so because we peeked. And that, dear reader, is quantum physics in a nutshell.
One wonders whether Schrödinger's Cat process is at work in the world of interest rates and inflation. Eighteen months ago, the real yield was at 2.17% (December 2003, since you ask). Practically no one knew or cared. Trustee meetings came and went - the performance of FTSE and the state of the bond markets were extensively discussed – but the real yield (on the 2% 2035 index linked gilt) wasn’t even on the agenda. Pension funds owned homeopathic amounts of it – so why worry about the yield? Thus, for the most part, it got shut in a box, the lid only lifted once every three years – which obviously wasn’t enough to do any harm.
But accounting standards boards, regulators and rating agencies have changed all that. Now the lid is well and truly open, with CFO’s, Treasurers, Consultants, Actuaries, Asset Managers and Trustees all looking into Schrödinger's box with a growing sense of disbelief. The real yield is in a sorry state – coated, you might say, in radioactive hydrochloric acid. And the more everyone looks, the further it seems to fall - as if the very act of observing, somehow affects the outcome. Schrödinger would be proud.
UK Real Yield on 4 July 2005 (Source: Bloomberg)
[Please note that all opinions expressed in this blog are the author’s own and do not constitute investment advice. Click here for full disclaimer]