U.S. Treasury yields are on track for their biggest weekly decline in more than a year on Friday as traders sift through the most recent inflation data in decades and buy into the Federal Reserve’s narrative of that price pressures will ease as supply chain bottlenecks and labor market shortages decrease during the second half of 2021.
Core inflation, which excludes volatile prices for food and energy products, is increasing at an annualized rate of 8.3% in the past three months, the fastest since 1982. Headline inflation, driven in part by year-on-year comparisons in food and energy, it is running at 5%, the fastest in more than 13 years.
Under normal circumstances, bond yields would rise rapidly in the face of such compelling inflation signals, as investors would lower Treasury prices to reflect the erosion of the value of future coupon payments. However, benchmark 10-year notes rose to a three-month low of 1.43% yesterday as economists looked at the impact of supply chain bottlenecks and labor market shortages, both of which They are expected to decline as the global economy fully emerges from the coronavirus pandemic later in the fall, on top of current price increases.
Is the bond market correct?
Well, it’s certainly harder to read the signals from the $ 20 trillion pool of US Treasuries these days, particularly now that the Fed’s balance sheet has passed the $ 8 trillion mark for the first time in history. , a figure that is almost double the total it had before. increase in bond purchases at the peak of the pandemic in March last year.
But delving into the May CPI report seems to suggest that at least part of the Fed’s “transitory” inflation narrative holds up: Used car prices, which rose 7.3% last month, will not continue to rise. forever, and neither are airline fares, which are jumping amid a rebound in leisure travel that simply isn’t being matched by demand from higher-margin business customers.
“Once the dust has settled and the details of the report have been assimilated, we expect politicians to react to the figure in the same way they responded to the April CPI,” said Ian Shepherdson of Pantheon Macroeconomics. “That is, leaders will argue that peak inflation will be ‘transitory’ or ‘transitory’ due to ‘bottlenecks’, which will fade or reverse over time, allowing inflation to fall to target without the help of rates. higher “.
“(Fed Chairman) Powell and his colleagues, however, have never explicitly stated to what extent inflation would rise as a result of these ‘bottlenecks’, or how long it would take for the monthly CPI and PCE figures to return a sustained pace consistent with the 2% year-on-year target, “he warned.
So where does that leave the markets?
“Nobody knows how to deal with inflation,” Bank of America noted in its weekly “Flow Show” report. “Everybody knows how to negotiate ‘don’t fight the Fed’.”
Weekly bond inflows, according to the report, rose to $ 12.5 billion, compared to $ 1.5 billion in stocks and just $ 700 million in gold. The overall allocations of its private client business, with $ 3.2 trillion in assets under management, indicate a record exposure of 64.6% to stocks, 18% to bonds and 11.1% to cash.
Wage inflation could certainly heighten market concerns, if not those of the Fed, with the most recent job offer data from JOLT showing a record 9.3 million job openings in the US job market, Lo which suggests that employers should raise wages even beyond the last one. 2% increase per month to attract people to return to the workshop.
And with China reporting the largest increase in factory prices since 2008 last month, creating the prospect of “imported inflation” in the coming months, and Germany recording a drop in industrial production for May as a result of disruptions in the supply chain. In supply, even as order books remained bloated with post-pandemic demand that manufacturers were unable to meet, growth and inflation dynamics remained finely balanced with the fate of bottleneck relaxation.
“While we were hesitant to call that spike in inflation expectations given the ongoing bottlenecks in supply chains, there was a distinctive air of a ‘buy the buzz, sell the news’ dynamic to us,” Ryan said Detrick, Head of Market Strategy at LPL Financial CPI data for May.
“However, the next few months will be revealing as we are now entering the ‘show me’ phase of the inflation debate where market participants will be increasingly eager for the Fed to prove its claim that higher inflation will be transitory, “he added.