BOND MARKET WAKES UP TO INFLATION

On 10 November, the day the U.S. Bureau of Labor Statistics reported that October’s inflation rate spiked to 6.2 percent, the U.S. bond market finally seemed to take note of rising prices.
After showing no awareness of inflation for months, both short-term and long-term treasury bonds fell in price and yields for both rose.
As bond prices fall, indicating less demand, bond yields rise in order to be more attractive to investors.
A rise in short-term rates can signal the market’s expectation that interest rates will rise shortly; a hike in long-term bond yields would indicate the market expects inflation to remain high for an extended time.
Inflation erodes the value of bonds’ fixed-interest returns, causing bond owners to sell and buyers to demand higher interest rates to counter inflation.
Also on 10 November, the Dow Jones Industrial Average shed 240 points from its week’s high above 36,300 and the NASDAQ shrank by 260 points. The markets failed to regain their highs by the week’s close, snapping a string of five weekly gains.
“Wednesday’s market reactions suggest that investors are preparing for both higher inflation and aggressive moves by the [U.S. Federal Reserve] over the next two years,” The Wall Street Journal noted.
However, “this is not a panic reaction,” strategist Lou Brien at DRW Trading Group told the WSJ.
“It’s much too soon” to think the Fed will speed the end of its bond-buying market supports or suddenly jack interest rates, he said.
Investors expect inflation to run hot “for the foreseeable future” but that its pace will slow toward the Fed’s target 2-percent rate as supply-chain clogs dissipate, the holiday spending spurt passes, and producers are better able to satisfy demands for goods, according to the WSJ.
TREND FORECAST: As we noted in “Investors Energize Junk Bond Market Despite Growing Risks” (2 Nov 2021), now that the Fed is beginning to cut its monthly bond purchases, the junk bond market will brake sharply, killing companies that survived the COVID War on the Fed’s welfare checks.
The broader bond market also will shrink as the Fed withdraws and faces the prospect of a sharp correction once the Fed raises interest rates to 1.5 percent or more, as is likely during the second half of next year.