Since the Fed embarked on a path of monetary easing, news headlines and social media have been paying close attention to warning signs of inflation. The fear of upcoming inflationary pressures has been fueled by the recent dramatic rise in bold yields.
In August 2020 the 10-year bond yield hit a new all-time low of 0.52%. Since then the bond rate has been rallying more than 100 points to 1,73% in March 2021. Many have interpreted the recent upside momentum in yields as a leading indicator of future inflation.
On this post I'll simply discuss whether a steep increase in bond yields is a leading indicator for significant inflation shifts, or not.
Fear of inflation vs. inflation
A number of factors may drive bond yields higher, being fear of inflation among the primary ones. However fear of inflation is not the same as inflation. While inflation is a phenomenon where psychology always plays a key role, temporary fear of it from investors does not.
To illustrate this, we can compare the data for the 10-year bond yield and the CPI charts from September 2017 to October 2018. During that period the 10-year bond yield jumped over 100 points in about 12 months. Meanwhile, the CPI also climbed almost 100 points to 2.9%.
The charts above show that there is a strong correlation between both rates. However, the CPI rate initiated the reversal almost three months earlier than the 10-year bond yield.
Put it simply, in this case the CPI number worked as a bellwether of future bond yields, and not vice versa. Actually, the 10-year yield is a good benchmark for fear of inflation but not a bellwether of future inflation.
By the way, the trend reversal in October 2018 turned out to be significant since it was followed by a 18-month decline in the 10-year bond yield to 0.52% in March 2020.
Conclusion
Yields tend to rise with inflation, particularly with inflation expectations. Hence there is a strong correlation between both measures. But, we should never forget, the measure of something is not a leading indicator of something.
As for Inflation itself, it may be around the corner or not, regardless of the ongoing price action of the 10-year bond. Particularly, I believe that inflation is about to turn. In a coming post I will argue why higher inflation is almost inevitable in the coming years.
Sources
- Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate (DGS10), retrieved from FRED, Federal Reserve Bank of St. Louis; April 9, 2021.
- U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: All Items in U.S. City Average (CPIAUCSL), retrieved from FRED, Federal Reserve Bank of St. Louis; April 7, 2021.