Weekly Market Pulse: Bonds Didn’t Get The Inflation Memo

It was all over the news last week. Inflation has arrived. The CPI was hotter than expected. The PPI was even hotter. Import prices were up and export prices were up more. It was impossible to miss the inflation story last week. Stocks got the message and sold off on the hot CPI and finished the week lower for a change. Or at least that’s what I read in the press.

But curiously, there were two markets that didn’t seem to get the message: bonds and currencies. If investors were really worried about inflation there is one really obvious thing they would do – buy TIPS, inflation-protected bonds. And yet, with inflation readings providing all kinds of headlines, investors didn’t do that. In fact, on the day of that much higher than expected CPI, investors sold long-term TIPS, the 10-year yield rising by 4 basis points. If inflation fear is driving markets, TIPS investors are curiously brave. Nominal bond yields also rose on the week but the 10-year breakeven inflation rate actually fell by 3 basis points. Yes, in a week defined by the financial press as being dominated by inflation fears, investors with actual money on the line demonstrated nothing of the sort. On the currency front, the dollar was up the day of the CPI print and on the week as a whole. Real inflation is not just rising prices but rather a loss of purchasing power, most easily observed in a falling currency. The dollar has been volatile this year, up about 5% through March and down about 4% since but it is not falling as I would expect if inflation was really going to be a long-term problem. That could change but for now, if the dollar doesn’t fall, then this “inflation” will likely prove, to use the word of the year, transitory.

I don’t think you can even call this a buy the rumor, sell the news event. It isn’t like bonds had sold off recently and then didn’t react to this “news”.  The bond selloff that started last August accelerated earlier this year driving the 10-year yield all the way up to 1.76%. But more recently bonds have been moving the other way, the yield falling back to the 1.58% level. The move back up to all of 1.64% last week just isn’t enough to even warrant a comment except to say it isn’t worthy of comment. Bonds may indeed continue to sell off over the coming months as the recovery continues. That recovery though has been all I expected, advancing in fits and starts rather than the boom everyone else has been talking about. The emerging consensus seems to be that it would be a boom if the supply side of the economy would just get its act together if all the lazy bums would get off the dole and on the payroll. Maybe. Or maybe people are just acting a little more conservative – especially with their money – after their near-death – or worse – experience of the last year. Yes, I know social activity is on the rise these days after being freed from the tyranny of the mask but my concern all year has been that we’d get a short burst of activity that faded quickly. It is way too early to be doing victory laps on that score but I do think there are still some holes in that post-virus boom narrative.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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