Mon. Dec 6th, 2021


A number of bond bulls are betting that the world’s largest fixed-income market will shake up the rise in US inflation to a 30-year high, as long-term shifts in the US economy keep yields suppressed.

Data showing consumer prices Rose 6.2 percent in the year to October, the U.S. Treasury market briefly jerked earlier this month. However, yields on debt maturing decades into the future remain well below their 2021 peaks despite expectations for a protracted period of increased price growth.

For some long-standing bond bulls, the market’s nonchalance in the face of rising prices – typically kryptonite for debt investors – is a confirmation of the view that inflation will not leave a lasting dip in the market and, when the substance goes on the economic recovery lie, the pre-pandemic landscape of low interest rates will be largely unchanged.

“What matters is not this week’s. [gross domestic product] print or the following [consumer price index] pressure, or the next Fed meeting, are the fundamentals that drive the longer term, ”says Steven Major, HSBC’s head of fixed-income research. Those fundamentals, he argues, include America’s huge debt burden and an aging population.

Robert Tipp, PGIM’s head of global securities, also said that the prices of US government bonds – which are reversing to yields – would be supported in the long run by demographic trends and fiscal fundamentals.

Public debt line graph held by the public, showing US debt reaching the highest percentage of economic output since World War II

The argument driven by the bulls is that Americans approaching retirement – a large and wealthy generation – will increasingly switch to low-risk investments that provide consistent income streams over a long time horizon, such as treasury bonds. This cohort is expected to grow rapidly in the coming years, with the percentage of Americans 65 and older rising from about 17 percent in 2020 to 21 percent in 2030, according to projections by the U.S. Census Bureau.

The debt burden that the US has accumulated in recent years from fiscal spending and tax concessions, partly to support the US economy through the pandemic, could also limit the possibility of future lending, which further suppresses the growth prospects, some bond analysts say. Federal debt held by the public in 2020 reached 100 percent of gross domestic product for the first time since the aftermath of World War II, and is expected to continue to rise. Congress Budget Office estimates.

These long-term trends are pushing back against rising inflation and economic growth, both of which are raising yields on 10-, 20- and 30-year bonds higher. Many investors who bet that inflation will continue to rise are betting against longer-dated treasuries.

Bar graph of Nearly a quarter of Americans is projected to be older adults by 2060 showing America's aging population

For a stock bear like Sonal Desai, the chief investment officer at Franklin Templeton, there is no evidence that inflation will decline significantly. She noted that the Federal Reserve will continue to buy bonds next year, albeit at a slower pace than at the height of the pandemic, just as the government is deploying “another year of another massive amount of fiscal spending”.

“Overall policy remains very expansive. So these things together make me think that inflation will probably stay for a while longer, ”Desai said.

The stock bull thesis is not just about long-term trends – they argue that growth and inflation will not rise to levels that will change the course of those broad economic shifts. In terms of inflation, the bond bulls are in line with the Fed: they believe that although inflation is currently heating up, it is mainly driven by temporary forces such as supply chain disruption.

Some investors acknowledging the long-term waves that Major and Tipp are focusing on say they think these trends are unlikely to be the primary drivers of returns in the coming year.

These long-term drivers “will continue to be a force for lower rates in the future,” says Gregory Whiteley, portfolio manager at DoubleLine Capital, “but over the near term I will give greater weight to the cyclical and technical factors that drive higher returns. . ” These include rising inflation, upward trend growth and demand for treasuries of European and Japanese pensions.

Line chart of 30-year treasury yield (%) showing that long-term US bond yields are still suppressed by historical standards

The Fed’s decision earlier this month to begin delaying its $ 120 billion-a-month asset buying program – which will rob the treasury market of its biggest buyer – is unlikely to have a lasting impact on treasury yields, the bond bulls point out. the lack of any long-term correlation between the supply of bonds and their price.

“So the mortgage supply narrative is that there will be many more effects. “More supply brings the intuitive view that returns will have to increase,” said Major. “I see no empirical evidence of that. Honestly, I think that view is nonsense. “

Other investors are relatively relaxed about the Fed’s imminent departure, as it will come at a time when the US Treasury – and other major securities issuers around the world – are reducing the volume of their lending from levels that are at the peak of the pandemic has been reached.

“It is not clear to me that a decrease will necessarily mean a large increase in yield, not least because the net supply in many places will not actually be greater than it has been over the past few years, despite the fact that purchases will stop, ”said Isobel Lee, head of global securities at Insight Investment.

“We are not facing any kind of cliff,” she said.



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