Chart of the Week - Higher For Longer
Higher for longer risk is becoming reality for US Treasury Yields..
As geopolitical risk looms, bonds — typically a safe haven defensive asset, which typically get bid up in times of risk and uncertainty — are… getting further sold-off.
There’s two reasons for this: 1. Further flare-up and escalation in the Middle East geopolitics is likely to push up oil prices, inflation, and bond yields; but perhaps more important; 2. The main underlying current is one of reacceleration and inflation resurgence risk, and that is setting the tone and arguably speaking louder than the evolving geopolitical risk backdrop.
We saw a shot across the bows last week on this with the stickier than expected underlying inflation measures… meaning that all those expected Fed rate cuts everyone was looking for are as a minimum going to be smaller and later than expected, and the tail risk is that the next move could even be higher on rates.
Today’s chart highlights the linkages between inflation and bond yields.
The long-term rate of inflation model is a good predictor of the approximate level of bond yields over time, and is currently pointing to levels around 5%. But naturally, with many things like this there is every chance of overshooting the fair value yard stick.
Inflation resurgence of course would see that yard-stick move higher.
But here’s the thing, even if we forget about the (very real) risk of inflation resurgence, and just assume inflation eases back to the Fed’s 2% target, that is going to mean an elevated and actually upward drifting long-term rate of inflation over the next year.
AKA — higher for longer, at least for bond yields.
So while I want to be bullish bonds because of cheap valuations, and a handful of macro/market models that still point to the potential for lower yields (and an outside, but arguably current lower risk of recession), for now the technicals and fundamentals suggest the path of least resistance is for bond yields to head higher, or at the very least just make themselves right at home in this new higher range.
Key point: A higher long-term rate of inflation = higher for longer level of bond yields.
See also: Archive of previous Chart Of The Week reports
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