Treasury yields stormed higher through the first quarter of 2020, pricing in increasingly elevated inflation expectations through the year ahead. With inflation prints now showing numerous signs of heating up, the real test of the Fed’s commitment to abstain from rate hikes and let the economy “run hot” will begin.
Thus far, investors have been skeptical of the Fed’s assertions that they are relatively unconcerned with the prospect of “transient” inflation. But any sign of policymakers giving way to price pressures could pave the next leg up for yields and re-start the bond market sell-off.
Related ETFs: ProShares Short 7-10 Year Treasury (TBX), ProShares Short 20+ Year Treasury (TBF)
Throughout 2021, the sell-off in the bond market has only intensified, pushing up yields across the board. The yield on the US 10-Year Treasury note has risen 110 basis points (bps) from a 2020 trough of 0.54% to 1.64% on Wednesday. The 20 and 30-year yields, meanwhile, have seen even sharper increases of 134 and 133 bps over a similar period, respectively.
Though rising yields have roiled the Nasdaq’s high-growth stocks that shined in 2020, US Federal Reserve Chairman Jerome Powell has indicated he isn’t concerned about a recent rise in long-term bond yields, saying they appear to reflect growing optimism about the economy’s prospects.
That much is true, as rising yields mean investors are selling their bonds – a traditional safety net against economic uncertainty. Additionally, the yield curve has continued to steepen, meaning yields are rising more quickly at the long end – an especially strong indication that investors are preparing for stronger economic growth and the inflation that comes with it.
However, with greater inflation comes the prospect of interest rate hikes from the Fed – a facet of monetary policy that discounts corporate earnings projections – and, as it stands, investors simply aren’t believing Powell’s rhetoric about not raising rates if inflation breaks out significantly above the Fed’s long-standing 2.5% target.
Inflation Finally Heats Up, More Price Pressure Coming
Earlier this week, the US Consumer Price Index (CPI) showed a YoY increase of 2.6%, its strongest reading since August 2018. Though some downplayed that reading, given the significant base effect in play this month (an especially low reading in a previous year that influences an average reading to look stronger than it is in the next year), inflation may have actually been even more impressive on a monthly basis. The 0.6% jump MoM beat consensus estimates and marked a level unseen in almost 12 years.
Regardless, the base effect should not be ignored since it is very likely to contribute to levels of inflation between 4% and 6% over the next several months at the very least. Consistent monthly prints of 0.5% on the CPI would lead to annual increases at or above 4.5% for every month until August, when inflation would start moving toward 4.6%, and then as high as 5.9% by year end.
Even at a more moderate pace of 0.3% per month, we’d still see inflation in excess of 4.0% YoY by May and sustained inflation at or above 3.6% throughout each of the subsequent 7 months through the end of the year.
Although many are already expecting strong inflation, investors must have to wonder whether or not…