The US bond market may have undervalued the risk of inflation too much, according to mounting concerns.
Yields have dropped dramatically over the previous two months, and this is mostly owing to lessening fears of inflation. That is to say, inflation-protected yields, often known as “real yields,” have fallen by a smaller amount than their nominal counterparts. Their underwhelming showing is indicative of dwindling interest in hedges against inflation.
US Bond Prices
The bond market as a whole is sending signals that suggest a recession would be triggered by a Federal Reserve policy rate peak of anything less than 5 percent, necessitating a rate reduction of half a percentage point in the second half of the year.
Some people say there is very little room for error now. Demand for inflation-protected 10-year Treasury notes at this week’s auction indicates that investors are paying attention.
The average rate of increase in consumer prices over the life of the notes can be calculated by comparing the yields on real and nominal Treasuries. The yield on 10-year notes dropped to a year low of 2.09% this week. Inflation over the long term (2-5) has fallen to 2.13 percent, within a basis point of last year’s low.
Given these expectations, the overall Treasury market has soared 3.1% this month, making up for a historic 12.5-point drop in December. At the five-year mark, yields have fallen by the most (44 basis points), albeit they have fallen across the board. Yields for long-term investments of five to thirty years currently sit below 3.8%.
Investors Are Having Second Thoughts
According to Alan Ruskin, chief international strategist at Deutsche Bank, the bond market has started off to a very hot start this year and it should slow down. There is a limit to how low Treasury yields can go if the Fed drops to 5%.
Breakeven rates once again appear quite low due to commodity price and credit spread fluctuations, according to a study issued on January 19 by JPMorgan Chase & Co.’s inflation economist Phoebe White. Christopher Waller, governor of the Federal Reserve, stated the market is unduly optimistic about the pace of inflation’s decrease on Friday.
In an indication that investors are having second thoughts, they flocked to Thursday’s TIPS auction for 10-year Treasury securities.
The auction yielded 1.22 percent, which is around 4 basis points below where it was trading at the close of bidding, indicating that demand exceeded expectations. Customer bids sidelined primary dealers, who were awarded a record-low 7.6 percent share of the total. The ratio of total bids to the amount offered was 2.79, the highest since 2019