I blog about inflation over and over b/c its potential to send interest rates into the stratosphere and to disrupt our entire economy is so strong.
The last time we saw significant inflation in the 1970s, the stock market tanked and didn’t recover for a decade and interest rates remained in double digits for years.
INFLATION HITS 5%!
So, when I saw this headline in the WSJ, U.S. Inflation Is Highest in 13 Years as Prices Surge 5%, I thought for sure we’d see rates jump … finally.
But, rates fell… again.
So, we will very likely NOT see “4% rates by June,” even though this blog from March suggested it was a strong possibility.
I also blogged last month about why we are not seeing higher rates in the face of significant inflation, and included the following reasons: (1) the markets already priced it in or accounted for it; (2) investors think it is transitory; (3) The Fed is doing a good job of suppressing rates; (4) investors believe a recession is still on the horizon; and (5) investors have few other places to park money other than bonds, and that keeps rates low.
WHAT DOES THE BOND MARKET KNOW?
Today, I saw another headline in the WSJ with additional insights: What Does The Bond Market Know About Inflation?
This is significant b/c bond investors drive interest rates as much as any other factor. This is b/c if yields are too low, they will stop buying bonds and thus force interest rates higher overall.
But, they are not forcing rates higher despite all of the inflation we are seeing, and the question is why? Investors apparently believe inflation is transitory, as per this excerpt from the article:
“Core consumer price inflation of 3.8%, the level reported Thursday, has never been recorded in the post-1985 period alongside a 10-year bond yield of less than 6%. That indicates a fairly overwhelming belief on the part of investors that inflation is transitory.”
Yes, the Fed is a huge player in the bond market now, but investors still dominate about 75% of it, according to the article.
Hence, these investors are making a massive bet that inflation will not return in force.
And, I always give sophisticated investors with so much skin in the game far more credence than I ever give economists who have no skin in the game.
But, have the markets ever been wrong? Yes – very.
The 1929, 1987, and 2000 stock market crashes come to mind, as does the Great Financial Crisis of 2008.
But, most of those corrections involved a lot of much less sophisticated consumer or retail level investors.
Institutional investors like those who influence the bond market tend to be more sophisticated and rational, so hopefully they are right this time.
A lot of President Biden’s critics are accusing him of stoking the flames of inflation with his monetary and fiscal policy.
But those critics are also often the same people who extol the virtue and accuracy of the markets – which are currently “screaming” that inflation will not be a major issue.
What this tells me is the same thing I have been repeating for ten years – we are in unprecedented times and nobody has any idea of what will actually happen.
I remain very encouraged by the bond market nonetheless.
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