Investors have become increasingly concerned with inflation, and inflation hawks have cited historic stimulus measures and accelerating economic activity as tailwinds that could lead to runaway inflation. February’s consumer price index (CPI) release should help keep some of these concerns at bay. Headline CPI rose 0.4% month over month, in-line with the Bloomberg consensus forecast. However, core CPI, which controls for volatile food and energy prices, rose 0.1%, below the Bloomberg consensus of 0.2%.
Weather-related disruptions to energy production in Texas and other oil-producing states pushed headline CPI higher, but the softer than expected core price reading should help contain the market’s inflation jitters—at least for now. While inflation has been well contained for the past couple of months, data for March—and the subsequent months thereafter—will garner particular attention as the base effects for year-over-year data will begin to appear in the numbers, and the effects of continued reopening will begin to make their way into the services sector. Adding to the calls from inflation hawks is the soon-to-pass sixth coronavirus stimulus bill, which is sporting a price tag of nearly $1.9 trillion–creating a total of roughly $5 trillion in fiscal aid since the beginning of the pandemic.
Despite so much attention on inflation, the recent rise in bond yields hasn’t been primarily driven by investors demanding a higher yield to compensate for rising prices. As shown in the LPL Chart of the Day, real Treasury yields—those adjusted for core CPI—have been moving higher as economic growth has surprised to the upside in 2021:
Historically, gold has had a strong inverse relationship to real yields, as the precious metal has been a popular hedge for inflation. Now that Treasury yields are rising more on growth prospects than normalizing inflation, gold has stalled out. “After skyrocketing into the summer, the soft-dollar environment hasn’t been enough for gold to overcome the rise in real yields, “added LPL Financial Chief Market Strategist Ryan Detrick. “The recent surge in Treasury yields has seen real yields climb with them, showing the market is demanding higher yields because of economic growth rather than just accounting for inflation risk.”
While gold hasn’t been offering safety from rising bond yields, more-credit sensitive areas of the bond market have been showing strength. In particular, bank loans provide investors with the most yield per unit of interest rate risk, even if short-term yields remain anchored by Federal Reserve policy. We upgraded bank loans to neutral in our February Global Portfolio Strategy publication, as we believe they are an increasingly attractive opportunity for suitable investors.
If bond yields continue to climb, we may see further demand for interest rate protection in these more credit-sensitive sectors, particularly against a backdrop of an improving economy.
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