Business & Investment

Is the bond market giving a clear signal about inflation or is it distorted?

An important debate for investors is whether the rise in inflation is temporary or permanent, but using the bond market as a guide can be misleading.

In the first quarter of this year, government bond yields rose in line with textbook-style inflation and economic growth, and everything seemed very simple. However, since peaking at 1.77% at the end of March, the 10-year benchmark US Treasury has fallen below 1.30% despite a strong economic recovery and CPI numbers hitting highs for the first time in years. rice field.

Currently, there is a large debate about what is happening about the two managers I admire most have slightly different views on this issue.Team Ruffer Investment Company (LON: RICA) Recently said in their year-end review, “Our confidence at the end of long-term inflation is higher than ever, but we recognize the fact that the road to that point is not straightforward and the timing is uncertain.”

Sebastian Lyon, Manager Personal Asset Trust (LON: PNL)Said that less certainty, bond markets could probably give us a reasonable indicator that inflation may not be potentially acceptable this time. .. “There is definitely a risk of high inflation and high nominal yields, but at this point we are open-minded.”

Why did yields fall and why is it important?

Analysts have speculated why yields are declining. One suggestion is that the more contagious delta variants impair recovery and peak growth has already been achieved. Other possibilities include diminishing expectations for further stimuli and diminishing the impact of the financial benefits introduced during the blockade.

Alternatively, more investors may have accepted the Fed’s claim that the increase in inflation is temporary and that the pandemic distortions subside once they pass through the system. This does work, but it’s impossible to know how calm things are.

When inflation and yields peak and we return to the low-growth, low-inflation environment we are accustomed to, we tend to prefer growth stocks over value, and some commodity prices may settle. However, there is another potential explanation.

Is it the Treasury?

There’s no secret about the fact that the Fed buys $ 80 billion in Treasury and $ 40 billion in mortgage-backed securities a month as part of a quantitative easing program that keeps yields down, but the U.S. Treasury also It has played an important role in recent months through the general account held by the Federal Reserve Board. This is essentially a federal checking account.

It had accumulated about $ 1.8 trillion in balance last year, but wants to reduce it to about $ 450 billion by the end of July, when Congress must approve a new deal to allow the government to continue borrowing money. Stated. There were concerns that it could be accused of stockpiling cash before the deadline, but as a result, over $ 1 trillion in liquidity has flooded the system in recent months, some of which is the Fed. I arrived at the overnight reverse repo facility. You will definitely end up in the Treasury.

It’s clear over time whether the extra liquidity has given a misleading signal from the bond market, or whether inflation is really temporary, but in any case, both Ruffer and Personal Assets should work. is. Each of these defensive multi-asset trusts is positioned during a period of ongoing monetary restraint where interest rates are held below inflation. This scenario should be true regardless of the final inflation rate.

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Is the bond market giving a clear signal about inflation or is it distorted? Is the bond market giving a clear signal about inflation or is it distorted?

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