Bond Market Says Inflation Will Continue. You must be listening.


Almost everyone – used car buyers, tenants, homeowners with large heating bills, and stock market investors – have been worrying about rising prices lately. However, despite some of the fastest price increases in decades, investors in the Treasury bond market, eagerly adjusting to inflation, persisted in their belief that it was a temporary phenomenon.

This is changing now.

A key measure of the bond market’s inflation expectations over the next five years — known as breakeven — rose briefly above 3 percent on Friday to a new high. This meant that investors expected inflation to average 3 percent a year for the next five years, much higher than at any time in the decade before the pandemic hit. Measures of inflation expectations for longer periods such as the next 10 years also rose to multi-year highs.

Bond investors’ expectations are important because, historically, Federal Reserve officials responsible for managing inflation watch for signals from the bond market when deciding when to raise interest rates. Higher rates tend to curb inflation – but can also lower stock prices and slow hiring.

“They put a big stake in inflation expectations,” said Steven Friedman, a senior macroeconomist at the money management firm. MacKay Shields, once a market analyst at the Federal Reserve Bank of New York. How investors position themselves influences how Fed policymakers think, because “those who voice their opinions have skin in the game,” he said.

While Fed chair Jerome H. Powell and other central bank officials have spent months saying that high inflation is a “temporary” result of supply chain problems from the pandemic, there’s good reason to believe that recent price increases may be more inflation. persistent anxiety. The September Consumer Price Index reading, released last week, showed prices rose 5.4 percent year-on-year, slightly faster than growth in August.

But analysts say the top concern for bond market investors is that prices, apparently unrelated to the pandemic, are also starting to rise. Foremost among these were monthly rents, which tended to rise over the long run once they started to rise. Rents rose 0.5 percent from August to September, the fastest increase in nearly 20 years.

“The market saw this as proof that the recovery in inflation wasn’t going to be as temporary as the Fed had hoped,” said John Briggs, bond market strategist at NatWest Markets in Stamford, Conn.

Energy prices also rose 25 percent last month, driven by sharp increases in gasoline and fuel costs. Rising crude oil prices are behind the rise and there is little sign that these pressures will fade any time soon. Benchmark American crude oil prices continue to rise, rising 11 percent in October alone and nearly 70 percent for the year.

At the same time, Covid-related production barriers such as the stop-start recovery of auto production continue to keep other prices high. Last week, a report on wholesale used car prices, which It has become a closely watched inflation indicator on Wall Street.showed that the prices that dealers pay to stock their lots have increased once again. These prices will filter into consumers and will likely keep used car prices high for months.

All these factors have led investors to buy inflation-protected Treasury bills and sell plain Treasury bonds to keep up with inflation.

The difference between the yields of these two types of bonds is called breakeven and provides $20 trillion plus a ballpark estimate of what will happen to prices for those who invest in the Treasury bond market.

Their opinion is very important. For decades, the Federal Reserve’s decisions about what to do with interest rates and monetary policy have been heavily influenced by the idea that inflation is as much a psychological process as it is an economic one. Rising inflation expectations can become a kind of self-fulfilling prophecy, so the Fed tends to raise interest rates or otherwise tighten monetary policy when the public expects higher prices.

Many analysts expect the Fed to react similarly this time – but a rate hike won’t be the first step.

Before that happened, the Fed would have put an end to its extraordinary steps to protect the economy from the worst of the pandemic. That process is expected to begin at next week’s Fed meeting, when the key monetary policy committee will likely begin curbing bond-buying programs that have pumped $120 billion into financial markets every month since the pandemic hit. It’s unclear exactly how quickly the Fed will scale back this program, but investors now seem to be betting that it can be phased out by the middle of next year.

In recent days, market-based probabilities of a rate hike at the Fed’s June 2022 meeting have risen to roughly 60 percent, according to data from the CME. At the beginning of the month it was around 15 percent.

Investors are watching the Fed’s movements closely. Bond buying programs and low interest rates have been a boon to the stock market; The S&P 500 is up more than 100 percent since it started, including a gain of nearly 22 percent this year.

But some on Wall Street think markets may accept a methodical change in interest rates from the Fed, especially if it means keeping inflation in check.

“As long as you consciously steer clear of emergencies, I think markets will actually love it and growth can continue.Rick Rieder, head of the global allocation investment team at BlackRock money management firm, said:



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