Inflation Collides With Growth Fears to Trigger Big Swings in the Bond Market

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The 10-year Treasury yield rose to nearly 3.5% after reporting inflation, but declined as investors became more concerned about growth

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Specific factors driving those intraday moves include a surprise interest rate hike by the Swiss National Bank and a sharp drop in US stocks. More broadly, however, bonds are simultaneously being pressured by inflation and supported by increasing odds of a near-term recession.

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Yields on the Treasury, which largely reflected expectations for short-term interest rates set by the Federal Reserve, staged one of their steepest climbs in history this year as stubborn inflation forced the Fed to dramatically reduce its forecast. That’s how high rates will go.

Central bank officials have made rising yields a clear policy target. Higher yields translate into higher borrowing costs for businesses and consumers, which should ultimately lead to lower borrowing, lower spending and a slower rise in consumer prices.

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Therefore, the process of controlling inflation has given the worst bond returns on record since the 1970s. But any signs of success should boost the asset class, even as the economy is shrinking and investors are running away from riskier assets.

If interest rate expectations are stable, investors can benefit from new, higher-yield Treasuries without worrying about a further drop in prices. In addition, bonds should rally if the Fed cuts rates — or doesn’t raise them higher than currently expected — due to slowing growth and inflation.

The problem for investors now is that the economy is sending out uneven signals, showing warm inflation one day and, days later, evidence of sluggish housing demand and a sharp decline in consumer-and-business sentiment.

As a result of such cross-currents, “there’s no clear way to invest in bonds over a three-month horizon right now,” said Jim Vogel, an interest-rate strategist at FHN Financial.

The effects of declining stocks in a bear market have made matters more complicated for bond traders.

Falling stocks can send investors into Treasuries, which can incur short-term losses but still offer essentially guaranteed returns to maturity. They can slow the economy by taking away investors’ wealth and making it more expensive for businesses to raise money.

An optimistic scenario for bond investors is that falling stock prices could help tighten financial conditions, allowing the Fed not to raise interest rates as high as would otherwise be necessary.

But that dynamic can be difficult to maintain, as falling interest rate expectations and bond yields have sometimes rebounded stocks in recent months.

The volatility in the bond market continued till the end of last week. According to Tradeweb, the 10-year yield started at around 3.22% in Friday’s US trading session, peaking at 3.31% by midday and settled at 3.238%.,

Up from 3.156% last week.

Notably, yields didn’t end the week lower than last Friday, despite a surprise turnaround from the Fed, which provided investors with a 0.75 percentage-point increase on Wednesday instead of the expected 0.5 percentage-point increase. Until only two days ago.

The Treasury, in fact, rallied on Wednesday after Fed Chairman Jerome Powell indicated that the central bank was not necessarily committed to a 0.75 percentage-point rate hike. Falling stocks and weaker-than-expected data on retail sales, housing starts and industrial production contributed to a sense of gloom on Wall Street, giving the Treasury an additional boost.

The latest phase in yields led to a turnaround among some economists, who have long argued that investors were underestimating what was needed to cool an economy fueled by cash-flush consumers and an extremely tight labor market. Will happen.

Last year, when markets were pricing in the so-called terminal federal-funds rate of about 1.5%, former New York Fed Chairman William Dudley warned that the Fed needed to raise its benchmark rate to at least double that level. Will be

Early last week, however, the market-pricing of the terminal fed-funds rate was flirting with 4%, and at an event sponsored by Businesshala, Mr. Dudley said the market was now “far from what is right”. was within distance.”

Many investors share that view.

Roger Aliga-Diaz, chief economist at Vanguard of America and a principal in the firm’s investment-strategy group, said the 10-year Treasury yield had finally hit a nearly fair price level.

That, he said, is based on estimates that short-term interest rates should eventually settle at around 2.5% and require 0.5 percentage points to 1 percentage point to compensate investors for the risk of holding long-term Treasuries.

Some, however, warn that there is likely to be more pain ahead for Bond.

While the Fed has tried to cool the economy in the past, it has consistently seen the need to raise short-term rates above current levels of inflation, said Zach Griffiths, a senior macro strategist at Wells Fargo.,

Assuming that the Fed’s preferred gauge of inflation could fall to a mid-3% rate next year, it suggests the central bank should raise rates to 4.5% to get “in materially positive territory” on an inflation-adjusted basis. will need to be increased. He said that bond yields will increase further.

Write to Sam Goldfarb at [email protected]

Credit: www.Businesshala.com /

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