The “strange” response of bonds to U.S. inflation data confuses investors


The continued rise in US Treasury bonds was accompanied by the biggest burst of inflation in more than a decade, breaking the usually reliable model and allowing investors to scramble to explain what is happening in the world’s largest bond market.

Inflation is usually bad news for bond prices. It erodes the value of the fixed payments provided by bonds and makes it more likely that the central bank will respond by raising interest rates.

But in recent months, this relationship has reversed, at least for long-term debt. The price of U.S. Treasuries rose sharply—and other bonds around the world followed closely behind—this week lowering the 10-year Treasury bond yield from 1.75% at the end of the year to below 1.3%, the lowest point in more than three months in March.

“There are a lot of headaches,” said Mike Riddle, a portfolio manager at Allianz Global Investments. “On the surface, this move seems counterintuitive.”

Investors have been paying attention to the Fed’s recent changing signal about its sensitivity to rising inflation, which is an explanation for the seemingly unstoppable rebound in government bonds. Wall Street was on high alert in June after the Federal Reserve announced a “dot plot” of interest rate forecasts for policymakers. This suggests that monetary policy may be tightening much faster than the Fed initially stated last year, when the Fed accepted an average inflation target of 2%, including overshooting periods.

Federal Reserve Chairman Jay Powell discourages market participants from reading these personal forecasts too much, and urges patience for the eventual cancellation of policy support. But he also admitted that the Fed may need to deal with the risk of higher-than-expected price pressures.

“We are experiencing a substantial increase in inflation-larger than many people expected, and certainly larger than I expected-we are trying to understand whether it will pass soon, or whether we actually need to take action,” he said . At the Congressional hearing on Thursday.

“In any case, we will not enter a period of high inflation for a long time, because of course we have the tools to solve this problem. But we don’t want to use them in a way that is unnecessary or will interfere with the economic rebound.”

Coupled with the recent Fed officials discussing reducing the purchase of US Treasury bonds and institutional mortgage-backed securities of US$120 billion per month, this shift in stance has led many investors to believe that the Fed’s tolerance for out-of-control inflation expectations will be lower than before. . idea.

James Athey, Abrdn’s bond fund manager, said: “The Federal Reserve has effectively eliminated some of the more extreme situations that the market is worried about.” “The more interest rate increases are expected, the less inflation is expected to run out of control.”

The increasing number of coronavirus cases related to the more spreadable Delta variant has also raised concerns that the economic boom associated with the reopening of most of the world’s economies will not reach the extreme set by economists earlier this year. Optimistic forecast. But as the stock market rises near record highs, investors are reluctant to conclude that the bond market—a magnet in times of stress—is heralding a new grim outlook for the global economy.

On the contrary, many people continue to point out investor positions—a common culprit in volatility in the US Treasury market since the Fed meeting in June. In the first quarter of this year, as investors prepare for the reopening of the U.S. economy and the return of inflation, they bet that long-term yields will rise, while betting that the Fed will depress short-term yields. Many of the subsequent movements can be explained by investors abandoning those so-called steep trades—often reluctantly—because the market has disadvantaged them and their losses have increased.

Riddle said: “In the past few months, the grand narrative to explain this rebound has not worked.” “That’s why I think it makes sense to talk about positioning.”

Despite a series of setbacks, some people still insist on steeper transactions, believing that the apparent contradiction between soaring inflation and plummeting bond yields is unlikely to last. Chief Investment Officer Mark Dowding stated that at some point, the Fed will be forced to abandon its belief that current inflation will prove to be essentially temporary, as investors prepare to end stimulus measures more quickly. Will shake the bond market. Officials of BlueBay Asset Management.

“Bonds’ response to inflation should be naturally allergic,” Dowding said. “We suspect that we may review the current market period later this year and think that some of the trends we are witnessing are relatively strange.”

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