The bond market says inflation will continue. You must listen. – News Couple

The bond market says inflation will continue. You must listen.

Almost everyone — used car buyers, renters, homeowners with large heating bills and stock market investors — has been worried about the price hike lately. But despite some of the fastest price increases in decades, investors in the Treasury bond market who are highly inflation-adjusted have been steadfast in their belief that it was a temporary phenomenon.

This is now changing.

A key gauge of bond market expectations for inflation over the next five years — known as breakeven — rose to a new high, briefly reaching 3 percent on Friday. That means investors expect inflation to average about 3 percent a year over the next five years, much higher than at any time in the decade before the pandemic. Measures of inflation expectations over longer periods, for example over the next ten years, have also risen to multi-year highs.

Bond investor expectations are important because officials at the Federal Reserve — which are responsible for managing inflation — have historically watched signals from the bond market in deciding when to raise interest rates. Higher rates tend to curb inflation — but they can also reduce stock prices and slow hiring.

“They put a lot of money in the inflation expectations,” said Stephen Friedman, chief macroeconomist at the money management firm. Mackay Shields, who was a market analyst at the Federal Reserve Bank of New York. He said the way investors position themselves affects the way Fed policymakers think, because “those who put forward their opinions are very light in the game.”

While Federal Reserve Chairman Jerome H. Powell and other central bank officials have spent months saying that rising inflation was a “transitional” result of pandemic-driven supply chain problems, there has recently been good reason to believe that higher prices could be more to blame. constant worry The September CPI reading, released last week, showed prices rising 5.4 percent from a year earlier — and a bit faster than they were in August.

But analysts say the primary concern for bond market investors is that prices that seem unrelated to the pandemic are also starting to rise. Chief among them are the monthly rents, which tend to rise for long periods once they start rising. Rents jumped 0.5 percent from August to September, the fastest rise in nearly 20 years.

“The market saw this as evidence that the recovery in inflation would not be as temporary as the Fed had hoped,” said John Briggs, bond market analyst at NatWest Markets in Stamford, Connecticut.

Energy prices also jumped 25 percent last month, driven by sharp increases in gasoline and fuel oil prices. Rising crude oil prices are behind this rally, and there is no indication that these pressures will disappear any time soon. Benchmark US crude oil prices continue to rise, rising 11 percent in October alone and nearly 70 percent for the year.

Meanwhile, production hurdles linked to Covid, such as the sporadic recovery of auto manufacturing, continue to keep other prices high. Last week, a report on wholesale used car prices, which has become a closely watched indicator of Wall Street inflation, showed the prices dealers pay to buy their stakes are rising again. These prices will pass on to consumers, and most likely will keep used car prices high for months.

All of these factors prompted investors to snap up Treasury inflation-protected bonds, which increase their payments to keep pace with inflation, and sell regular Treasury bonds.

The difference between the yields on these two types of bonds is called the break-even point, and it offers something of an initial estimate of what those investing in the $20 trillion Treasury market think will happen to prices.

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

Many analysts expect the Fed to respond similarly this time around – although an interest rate increase wouldn’t be the first step.

Before that happens, the Fed will end the extraordinary steps it has taken to protect the economy from the worst of the pandemic. That process is widely expected to begin at next week’s Federal Reserve meeting, when its main monetary policy committee will likely begin reducing bond-buying programs that have been pumping $120 billion into financial markets every month since the pandemic emerged. It’s not clear exactly how quickly the Fed will abandon the program, but investors now seem to bet that it could be eliminated by the middle of next year.

In recent days, market-based odds of an interest rate increase at the Federal Reserve’s June 2022 meeting have jumped to nearly 60 percent, according to data from the Chicago Mercantile Exchange. It was about 15 percent at the start of the month.

Investors are watching the Fed’s moves closely. Bond-buying programs and low interest rates have been a huge boon to the stock market; The S&P 500 is up more than 100 percent since its inception, including about 22 percent this year.

But some on Wall Street believe that markets can accept a systematic shift from the Federal Reserve on interest rates, especially if it means keeping inflation in check.

“I have a view that as long as you are staying away from emergency conditions in a deliberate way, the markets are really going to like it and growth can continue., ” said Rick Reeder, head of the global allocation investment team at BlackRock Money Management.

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