If your historical perspective is defined the last several months, the recent jump in the benchmark 10-year Treasury rate looks significant. But a longer term view suggests otherwise. That will change if rates continue to rise, but at the moment the backup in yield still looks like one more installment of a long-running trend of fluctuation within a sliding trend.
The 10-year rate has been sliding for several decades, interrupted by periodic jumps that eventually faded. Is this time different? It may be if, as some economists predict, inflation is set to accelerate and effectively end the era of disinflation/deflation that’s endured since the mid-1980s.
The complicating factor is that inflation will accelerate in the immediate future due to so-called base effects. The year-over-year changes in inflation that compare prices today (and for the next several months) vs. the spring of 2020, when the pandemic was raging, will be unusually large. These comparisons say less about hotter inflation vs. reflecting the temporary deflation that prevailed a year ago when the coronavirus first roiled the economy.
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The real test is how inflation fares once the base effects wash out of the data. It’s tempting to look at one-month or three-month changes for an early clue, but there’s too much noise in these short periods to use these numbers as a guide. That leaves the more reliable one-year trend. But even here there will probably be more noise than signal until the second half of this year.
Meanwhile, the forecasts are all over the map. For example, David Roche, president of Independent Strategy, sees forces aligning that will drive inflation higher over the next several years. The combination of sharply higher government spending, unleashed pent-up consumer demand, a rebounding economy and other factors will drive the process, he explains.
“My own view is that we will see inflation of probably 3% or 4% by the middle of next year and that is completely inconsistent with, say, US 10-year bond yields being at 1.6%. That yield could easily double, and when it does, then you come to the crunch point that markets are going to experience,” he predicts.
There’s a growing chorus of analysts who agree, including former Treasury Secretary Larry Summers. “All the signs are for inflation starting to break out,” he said at a Council on Foreign Relations forum yesterday. Several inflation indicators are “flashing red,” he advised.
Yet there are a dedicated band of analysts who continue to argue that disinflation/deflation is still the path of least resistance due to the usual factors: globalization, technology, an aging workforce and other drivers. Jeff Snider at Alhambra Partners, outlined his view in an interview last week for why he’s still expecting inflation will remain muted and perhaps slip further once the pandemic noise fades. As he said on the MacroVoices podcast last week, the bond market, despite the recent pop in yields, continues to price in relatively soft inflation.
[Inflation remains low] despite trillions upon trillions and deficits and QEs worldwide [and] the universal basic income and MMT light that is now infecting official discussions and political considerations. There’s actually very little so far as inflation expectation, despite every one of those things…. There’s been a small but significant improvement in expectations over the past few months. But nothing, absolutely nothing more than that. And even that has been underwhelming, distinctly unimpressive.
Hoisington Investment Management has a similar view, recently advising:
Contrary to the conventional wisdom, disinflation is more likely than accelerating inflation. Since prices deflated in the second quarter of 2020, the annual inflation rate will move transitorily higher. Once these base effects are exhausted, cyclical, structural, and monetary considerations suggest that the inflation rate will moderate lower by year end and will undershoot the Fed Reserve’s target of 2%. The inflationary psychosis that has gripped the bond market will fade away in the face of such persistent disinflation.
But talk is cheap. The critical issues to monitor in the months ahead start with the incoming inflation data and the Treasury market. On the latter, keep your eye on the 3.0%-plus mark for the 10-year Treasury yield. This is where the rate topped out in late-2018. Why is that significant? It’s not only the previous high but it’s also a peak that modestly and briefly broke the previous 30-year-plus downtrend. In other words, if the 10-year yield doesn’t convincingly rise above the low-3% level, the case will remain compelling that the recent rebound in rates is noise in a longer-term slide.
For another spin on putting increases in Treasury yields into deeper historical perspective, consider the percentage change in the 10-year rate on a rolling one-year basis. As the next chart shows, periodic increases in the 10-year yield for the past 20 years have been in the range of 100% to 200% off the previous lows.
At the moment, we’re still in that range and so the latest jump in yield is par for the course to date. If and when the increase exceeds this range, inflationistas will have a stronger case for arguing that it’s different this time.
That is, unless you think the Federal Reserve is gearing up to manipulate the Treasury market on a deeper level with yield control at longer maturities. Alternatively, will the pandemic prove more resilient (and economically damaging) than currently priced into the bond market?
Assuming that it’s business as usual, or something close to it, the current rise in yields still looks like noise. The question is whether the numbers will tell another story in six months?
Meantime, cool your jets. It’s going to be a long summer.
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