The curious incident of the falling bond yields
Kevin Gardiner and Victor Balfour, Global Investment Strategists
Scotland Yard Detective: “The dog did nothing in the night-time”
Sherlock Holmes: “That was the curious incident”
US inflation significantly exceeded expectations in April, May and now June, with the annualised core rate at post-1981 highs. Despite the most startling inflation numbers in recent years, however, US Treasury (bond) prices are up. For good measure, gold is down and bitcoin briefly collapsed (again). Go figure, as they say.
Maybe the inflation guard dog has been quiet because, as in the Sherlock Holmes story, the culprit is known to them. The immediate inflation surge has looked largely ‘transitory’, caused by supply bottlenecks as the US economy reopens unevenly, and long-dated Treasuries ought not to respond to short-dated concerns.
Perhaps, also, there was just too much growth and inflation risk already priced-in after bonds’ earlier sell-off (and gold’s rally). More recently, bondholders may be digesting revived COVID-related deflation risk, and/or the fact that US growth has passed its cyclical peak. And many bondholders these days (such as central banks and liability-driven investors) simply don’t care, having bought bonds for non-economic reasons to begin with.
But we think longer-term inflation risk is rising – and if these short-term surprises persist, ‘transitory’ may start to look like ‘trend’. If virus suppression re-tightens, adaptation will continue; and while growth must decelerate anyway (you can only reopen once), it could stay above trend, eating up spare capacity, for a while yet.
We advise against taking money markets’ resumed faith in disinflationary conditions too much to heart, then. And while stocks will not be immune to renewed interest rate risk, we see the similarly quiet ongoing rise in projected corporate earnings as a more significant clue than bonds’ rally.
We think they can cope.
Kevin Gardiner and Victor Balfour
Global Investment Strategists