Powell was reasonably dovish yesterday. He immediately shut down a reporter who asked when we could talk about tapering. He reiterated the need to remain accommodative for longer than normal this time and that the Fed’s reaction function would not be as anticipatory as it had been in the past (i.e. they’re going to wait to actually confirm certain things are happening as opposed to merely being pretty sure those things are about to happen). The median Fed forecast still calls for 2 more years of zero rates. The list goes on.
But one counterpoint to the ostensibly dovish commentary is that by delaying the reaction function and tolerating 2.5%-ish inflation, the Fed runs the risk of ushering in an era of ACTUAL inflation–the likes of which we haven’t really seen in a long time (unless you look at home prices). As we know, bonds don’t like inflation. And if the Fed is willing to let it run hot, bond yields should move higher as a result. Indeed they already have, and inflation is certainly one of the key supporting actors in that story. But it’s absolutely not in the starring role. That part was given to covid at the start of the pandemic. As such, what follows is no surprise.
And what about inflation over this same post-vaccine period? Unfortunately, there’s no perfect way to measure it over such short time horizons, but the best solution is to use Treasury inflation-protected securities to reverse engineer a market-based inflation expectation. This is known as the TIPS “breakeven” (10yr yield minus the 10yr TIPS yield). Granted, there are a few other reasons one might buy TIPS, but inflation hedging is certainly one of them.
To be perfectly fair to TIPS, those yields did indeed spike in February in a way that coincided very well with the Treasury yield spike. One could even say that the abrupt bounce in TIPS is the x-factor behind the bond market’s shift into a higher gear of selling and pain. Here’s the chart they’d want to use to do that:
In other words, the 10yr sell-off was minding it’s own methodical business before TIPS took off. But while TIPS may have taken off, the inflation implication (that “breakeven” actually took off in December. Here’s how the same chart looks if we use the breakeven (again, that’s the market’s view of inflation) instead of TIPS yields themselves.
The chart above makes it hard to assess more recent correlation because the lines are so far apart (due to the use of 1/1/2019 as a baseline). The next chart uses 1/1/2021 as the baseline, and there we see the 10yr walking away from inflation expectations quite clearly.
Bottom line: there is not some new revelation about inflation that’s driving the pace of the yield spike. I’d keep looking at the covid charts for that, as well as a laundry list of supporting actors. The cast and crew just happen to be firing on all cylinders when it comes to making life miserable for bonds. Here are just a few of the players:
- Big Treasury issuance (ongoing)
- Big corporate bond issuance (ongoing)
- Japan Ministry of Finance selling TSYs heavily in March
- Actual economic optimism
- Prospects for a bigger-than-expected return to the labor force for millions of displaced workers (debatable, but it’s a factor)
- an eventual wind-down of Fed bond buying that we all know is coming
- Most recently doubts as to whether the Fed’s SLR temporary rule will be extended
- “I could take this money out of bonds and buy more stocks!” (hasn’t always worked like that recently… this is always a messy and overly-simplistic view, but it is nonetheless true that stocks have hit all-time highs recently as bond yields have been soaring.
In other words, there’s no new, specific answer for “what caused this?!” These yields were in the playbook, even if we’d hoped not to see them, and a big, rising rate environment was ALWAYS going to happen when the battle against covid really started going our way (and that’s “our way” in the sense of human beings, not from the standpoint of “mortgage pros who like low rates,” in case that needs to be clarified).