Team Transitory Lives! 12/21
The bond market still expects inflation to fade away
Recently, Paul Krugman conceded that inflation has been more persistent than “team transitory” had hoped for. Kudos to him for being forthright about it. In my Fantasy Intellectual Teams game, he would score an Open Mind point.
But there are some other members of Team Transitory who don’t write newspaper columns and instead play the forecasting game with real money. I am talking about investors in long-term bond markets. Reuters reported,
The Federal Reserve's more hawkish turn this week came amid heightened worries about economic recovery and inflation, but it has barely changed the bond market's view that short-term interest rates could top out below the U.S. central bank's estimated peak.
In the WSJ, James Freeman writes,
Lately in the United States, inflation has been outrunning the yield on the 10-year Treasury by more than five full percentage points. This brutal negative real return is worse than anything investors have received since an inflation event that really did prove to be transitory.
On December 16, the interest rate on 3-year Treasury securities was just under 1.0 percent. If you thought that inflation was going to average much more than 2 percent over the next three years, you would never invest in securities yielding just 1 percent. Instead, for example, you could invest in Treasury inflation-indexed securities, which protect you against higher rates of inflation. Even if you think that the Fed is going to use its magical powers to keep interest rates low in spite of inflation, you still would look for better returns.
Unless you think that there has been an outbreak of mass stupidity on Wall Street, you have to reckon with the fact that apparently the smart money believes that inflation is going to come down soon. Personally, I think that there has been an outbreak of mass stupidity on Wall Street. As Freeman puts it
Prices on U.S. government debt suggest that investors are supremely confident that inflation will soon decline and interest rates will stay low, even as the U.S. has lately become much more heavily indebted and therefore a more risky borrower—and just after the Fed proved it cannot accurately predict inflation. Who’s buying this stuff?
I am not gambling a lot of money betting that this outbreak will subside soon, but I am certainly not buying any three-year Treasury notes that aren’t indexed for inflation.