Bond Market Breaks Above Key Inflation Threshold – What Next?

Original post

Federal Reserve Bank of Atlanta President Raphael Bostic said today that he’s “comfortable continuing with a slow removal of policy accommodation,” because his main concern “is that inflation expectations risk becoming anchored below 2 percent.”

Which is ironic, since the 10-year inflation break-even rate, which reflects the yield premium on the 10-year U.S. Treasury note over the comparable Treasury inflation-protected security, topped 2% on Tuesday for the first time in more than nine months.

http://protradingresearch.com/wp-content/uploads/2018/01/20180108_BE2.png

Just as stocks have soared in recent weeks, so WSJ notes that the measure of the bond market’s expectations for inflation crossed a key threshold in the past week, highlighting investors’ renewed economic enthusiasm.

http://protradingresearch.com/wp-content/uploads/2018/01/20180108_BE1.png

The break-even rate hovered around 1.8% in November before gathering momentum as energy prices rose and as Congress moved forward with a plan to cut corporate taxes, which is expected to boost growth around 0.5% in 2018, according to BNP Paribas.

Investors are betting on TIPS even as inflation remains below the Fed’s target and as the central bank has embarked on a course of rate increases intended to prevent higher prices from taking root in the economy. Fed officials have signaled their intention to raise rates three times in 2018. Some economists, including those at JPMorgan Chase & Co., have said they expect the central bank to be even more aggressive in damping price pressures, predicting four increases this year.

http://protradingresearch.com/wp-content/uploads/2018/01/20180108_BE4.png

Signs investors are concerned about higher inflation aren’t confined to the bond market. Commodities such as oil, copper and aluminum – which are key industrial materials and often serve as bellwethers for the direction of consumer prices – are also rallying. So is gold, which has historically served as a store of value in times when inflation has been a concern.

However, the industrial commodity surge appears a little overdone…

http://protradingresearch.com/wp-content/uploads/2018/01/20180108_BE3.png

Still, WSJ reports  that some investors are hesitant to ride the current trend, noting that inflation expectations have climbed before in recent years, only to fall back down again.

Given recent history, long-term investors “are all a little hesitant to say that this is the moment that inflation expectations should be breaking out,” said Dan Dektar, a portfolio manager and head of liquid markets at Amundi Pioneer.

Especially considering just how net short Treasuries everyone already is…

http://protradingresearch.com/wp-content/uploads/2018/01/20180108_BE5.png

Perhaps the breaking of this 2% threshold is what triggered China to reverse its position – that appeared to be the catalyst for the last few months panic-buying.