Bond Market Unsettled by Inflation Concerns

From a broader perspective, the August 2020 low may have marked the end of a 40-year bond bull market. The low 10-year yield that summer was the culmination of a decline from a peak of more than 15.8 percent in 1981. That peak came, not coincidentally, when Paul Volcker was Fed chairman and the Fed Index. Consumer prices was rising. at a rate of 14.8 percent. After Mr. Volcker beat inflation, interest rates began their long decline. Now, along with inflation, they are rising and that change is affecting the price of a wide range of bonds.

The current level of the 10-year Treasury, almost 2.5 percent, represents a huge rise in yield from that low point, and a nasty drop in bond prices, made even more painful because much of it has happened. since the start of this calendar year, when the 10-year yield was just 1.51 percent.

What has happened since then? In short, the consumer price index hit an annual rate of 7.9 percent, the unemployment rate fell to 3.8 percent, and Russia invaded Ukraine, sending oil and other commodity prices skyrocketing. critical importance. In the face of all this, at its last policy-making meeting, the Federal Reserve Open Market Committee began raising the fed funds rate and said it would continue to do so. Jerome H. Powell, chairman of the Fed, has promised with increasing urgency to do whatever it takes to bring inflation down to more modest levels.

The sharp rise in bond rates has produced some dislocations along the way, sending signals that, in the past, have sometimes meant a recession was on the horizon. They are worth monitoring closely, but the picture they give now is murky at best.

First, some background: Bond rates are set by traders in the market, not the Federal Reserve. Typically, when the economy is growing, investors receive a premium for lending money for longer periods. But sometimes short-term interest rates are higher than long-term rates.

When that happens, the bond market calls it a “yield curve inversion” and implies, at a minimum, that financial conditions are tightening and, possibly, that economic activity will slow so much that a recession is looming. .

In recent weeks, there have already been yield curve inversions, and there are likely to be more. But what does it mean?

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