“We think that the U.S. economic slowdown underway will put downward pressure on inflation for the next four to six quarters. Inflation is a lagging indicator of economic growth, and it will likely reach the point this year where it ceases to be a major concern for Federal Reserve policy makers, who will then shift their focus to easing monetary policy to address a soft economy.”
So wrote John Brynjolfsson, managing director and portfolio manager at the giant bond shop PIMCO in his February commentary. The bond market this month seems to agree with Brynjolfsson’s bullish scenario for fixed income. The return of buying the 10-year Treasury Note pushed the yield to under 4.80% by last week’s close, down from around 4.90% in late January. The buying may or may not have legs, but for the moment, a cautious optimism has the floor.
Nonetheless, this is no time to take a nap or mindlessly commit gads of long-term money to bonds. Consider that while Brynjolfsson sees 2007 as a generally positive year for bonds, the longer-term outlook isn’t quite so rosy. “Beyond the five-year horizon,” he wrote, “we are very concerned about inflation, largely based on the growing mountain of obligations, liabilities and unfunded promises being heaped upon the government and corporations by demographic shifts.”