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Fixed-income investors are fixating on the idea that trillions worth of pandemic stimulus could end up eroding the value of their holdings by pushing inflation up too quickly.
But one obscure slice of the U.S. bond market might be suggesting that reflation is only temporary.
Take “break-even inflation rates,” which are derived by trading in Treasury inflation-protected securities. After a near year of upheaval brought on by the coronavirus pandemic, break-even inflation rates recently were trading at much more elevated levels over a short-term horizon, than on a longer-term stretch, suggesting that some investors expect a pickup in near-term inflation, but then for it to taper off.
The 10-year break-even rate stood at 2.10% Monday, while the 5-year rate was at 2.21%. Back at the start of January, when investors began to focus keenly on break-evens, they were at 2.01% and 1.98%.
Inflation worries have come to the fore since Democrats won control of the White House and the Senate after the November election and subsequent runoff contest, and as the Biden administration vows to “act big” to help bridge the economy and households through the pandemic.
See: Inflation inflection? It’s coming, this analyst says
Tony Rodriguez, co-head of fixed income at Nuveen, said the recent kink in the break-even rates curve could indicate investors have been anticipating “base effects,” in the market.
For example, weaker inflation readings in March and April at the onset of the economic crisis sparked by COVID-19 is expected to skew yearly inflation measures and temporarily lift annual inflation rates over the next few months, before they ebb later in the year.
The inflation signs come as investors debate whether the combination of an accommodative Federal Reserve, supply-chain disruptions and trillions of fiscal relief could push inflation higher on a more lasting basis.
However, Rodriguez cautioned it may be unwise to read too deeply into the market action in TIPs, notoriously illiquid investments that could give deceptive signals on where investors feel inflation is headed.
Even more to the point, Tim Magnusson, senior portfolio manager at Garda Capital Partners, argues it’s the heightened interest in inflation insurance, itself, that has produced the inversion in the break-even rates curve.
Much of the inflows into TIPs have come via exchange-traded funds as interest in inflation protection has broadened beyond large money managers.
The average maturity of these TIP exchange-traded funds tend to sit on the shorter side, with the iShares TIPs Bond ETF TIP, -0.20% having a maturity of 8.15 years.
The inflows arriving into shorter-term maturities have, in turn, pushed their yields lower and propelled short-term inflation expectations higher.
In broader markets, the S&P 500 SPX, +1.61% and Dow Jones Industrial Average DJIA, +0.76% were attempting to claw back losses from last week. Meanwhile, the 10-year Treasury note yield TMUBMUSD10Y, 1.068% fell 1.3 basis points.
