The Money Illusion: Look at what’s “Real

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The Money Illusion Look at whats Real

• In behavioral economics there is a theory called
  money illusion, which is the tendency of people
  to think of currency in nominal terms, rather
  than in real, or net of inflation, terms. With
  nominal interest rates on the rise and at their
  highest levels in over a decade, it is timely to
  remind investors of the importance of thinking in
  real terms, and not just nominal.
• Since December 2015, the US Federal Reserve has
  increased the Federal Funds rate six times, from
  an effective 0 yield to todays 1.75 (as of
  5/23/18). The nominal yield on Treasury bills
  (those with maturities less than one year) has
  also increased, rising from an average of 0.35
  in December 2015 to 2.02 today, as shown in the
  chart below. After nearly a decade of 0 yields
  following the financial crisis of 2007-2008,
  todays 2.02 nominal yield on cash-like Treasury
  bills has many investors excited about the
  prospect of earning a return on their
  cash/savings.

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Source FactSet, Athena analysis
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Source FactSet, Athena analysis
While an increase in yields is a positive data
point to support the legitimacy of an economic
recovery, our enthusiasm thus far for the rise in
yields is tempered when we consider the yield net
of inflation. Our enthusiasm is further tempered
when we consider the 2.02 yield on a real,
post-tax basis. In the chart below we show the
historical real yield and real, post-Federal tax
yield of the six-month Treasury bill from April
2003 through March 2018. We also show the nominal
yield of the six-month Treasury bill for
context. Source FactSet, Athena analysis
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From the above we see that the current real yield
available on six-month Treasury bills is positive
for the first time since 2008. This is great news
for tax-exempt investors as it means Treasury
bills no longer offer return free risk. For
taxable investors, however, there is still 65
basis points to go before the real, post-tax
yield is above 0. There are of course a
multitude of reasons why an investor may prefer
to hold cash, regardless of the real or real,
post-tax yield. However, as Treasury yields rise,
we wanted to remind investors of the money
illusion and to think in real terms before
getting too excited about the rise in nominal
yields. Article Resource  https//www.athenacapi
tal.com/blog/the-money-illusion-look-at-whats-real
/