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A relentless concentration on U.S. treasuries has accompanied the biggest inflation boom in more than a decade, which has achieved typically reliable guidelines and left investors looking for an explanation for what is happening in the world’s largest bond market. .
Inflation is often bad news for bond prices, eroding the value of fixed payments offered by debt, and central banks are more likely to respond with rising interest rates.
But recent months have changed that relationship, at least for debt with a longer date. U.S. Treasury prices have gained big gains (with other bonds around the world following in their footsteps) and have made ten-year yields the lowest in more than three months this week, below 1.3%, from 1.75% at the end of March.
“There are a lot of headaches,” said Mike Riddell, portfolio manager at Allianz Global Investors. “Apparently, this move seems pretty counterintuitive.”
Investors have pointed to recent Federal Reserve signals about its evolution from sensitivity to high inflation, as an explanation for the unstoppable emergence of government bonds. Wall Street was put on high alert in June after the Fed’s “points plot” of policy makers’ interest rate projections was released. This suggested the possibility of a much faster tightening of monetary policy than was initially indicated when the Fed adopted an average inflation target of 2% last year that would include periods of overrun.
Fed Chairman Jay Powell has discouraged market participants from reading too many of these individual forecasts and urged patience over the eventual removal of policy support. But it has also acknowledged the risk the Fed may need to respond to higher-than-expected price pressures.
“We are experiencing a sharp rise in inflation, bigger than many expected and certainly bigger than I expected, and we are trying to understand if this is something that will happen fairly quickly or if, in fact, we need to ‘act,’ he said. Thursday in a congressional hearing.
“One way or another, we’re not going to go into a period of high inflation for a long period of time, because of course we have the tools to fix it. But we don’t want to use them unnecessarily or interrupt the rebound. of the economy ”.
Along with the recent admission that Fed officials are beginning to debate the reduction in monthly purchases of $ 3 trillion and $ 120 billion in mortgages, this change in stance has convinced many investors that the Fed will be less tolerating runaway inflation expectations than before. thought.
“The Fed has effectively eliminated some of the most extreme scenarios that worried the market,” said James Athey, Abrdn’s bond fund manager. “The more expectations are raised for rate hikes, the less inflation is expected to go out of control.”
Growing cases of coronavirus related to the more transmissible variant of Delta have also renewed fears that the economic boom linked to the reopening of large swathes of the world economy will fall short of the extremely optimistic forecasts presented by economists in early year. But with equity markets around record highs, investors are reluctant to conclude that the bond market (a magnet in times of stress) is signaling a recently bleak outlook for the global economy.
Instead, many continue to point to the positioning of investors, a family culprit in Treasury market riots since the June Fed meeting. In the first quarter of the year, as investors prepared for the reopening of the US economy and the return of inflation, they bet heavily on longer-term yields, while betting that the Fed would maintain fixed short-term profitability. Many of the subsequent moves are explained if investors abandon so-called strengthening transactions, often reluctantly, as markets confronted and losses increased.
“None of the great narratives that explain this concentration have been working in recent months,” Riddell said. “That’s why I think it makes sense to talk about positioning.”
Despite a number of setbacks, some are holding on to stronger trade, arguing that the apparent contradiction between rising inflation and falling bond yields is unlikely to last. At some point, the Fed will be forced to move away from its view that current inflation will be largely transient, shaking the bond market as investors prepare for a faster stimulus reduction, according to Mark Dowding, chief official investor of BlueBay Asset Management.
“Bonds should be naturally allergic to their reaction to inflation,” Dowding said. “We suspect we may look back at the current period in the markets some time later in the year and consider some of the trends we are witnessing to be relatively strange.”
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