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The bond market says inflation is going to last.  You should be listening.

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The bond market says inflation is going to last. You should be listening.

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Almost everyone – used car buyers, renters, homeowners with big heating bills and stock investors – is worried about the price hikes of late. But despite some of the fastest price increases in decades, investors in the highly inflation-sensitive Treasury bond market were firmly convinced that this was a temporary phenomenon.

It’s changing.

A key measure of the bond market’s expectations for inflation over the next five years – known as the breakeven point – hit a new high on Friday, briefly exceeding 3%. This meant that investors were expecting average inflation of around 3% per year over the next five years, much higher than at any time during the decade before the start of the pandemic. Measures of inflation expectations over longer periods, such as over the next 10 years, have also reached multi-year highs.

The expectations of bond investors matter because historically Federal Reserve officials – who are responsible for managing inflation – monitor bond market signals to decide when to raise interest rates. Higher rates tend to dampen inflation, but they can also lower stock prices and slow hiring.

They place great importance on inflation expectations, ”said Steven Friedman, senior macroeconomist at the management firm. MacKay Shields, who was formerly a market analyst at the Federal Reserve Bank of New York. The way investors position themselves influences the way Fed policymakers think, he said, because “those who present their opinions are in the game.”

While Fed Chairman Jerome H. Powell and other central bank officials have spent months saying that the rise in inflation was a “transient” result of supply chain problems caused by pandemic, there has recently been good reason to believe that rising prices may be of more lasting concern. The September Consumer Price Index, released last week, showed prices climbed 5.4% from a year earlier – and slightly faster than they rose in August.

But analysts say the crucial concern for bond market investors was that prices seemingly unrelated to the pandemic were also starting to rise. Foremost among these were monthly rents, which tend to rise over long periods of time once they start to rise. Rents jumped 0.5% from August to September, the fastest increase in about 20 years.

“The market saw this as proof that the pick-up in inflation will not be as transient as the Fed had hoped,” said John Briggs, bond market strategist at NatWest Markets in Stamford, Conn.

Energy prices also jumped 25 percent last month, led by sharp increases in gasoline and fuel oil costs. Rising crude oil prices are behind the surge, and there are few signs that these pressures will disappear anytime soon. Benchmark US crude oil prices continue to climb, increasing 11% in October alone and about 70% for the year.

And at the same time, production issues related to Covid, such as the intermittent recovery in auto manufacturing, continue to keep other prices high. Last week, a used car wholesale price report, which has become a closely watched inflation indicator on Wall Street, showed the prices dealers pay to stock their lots were rising again. These prices will trickle down to consumers, which will likely keep used car prices high for months.

All of these factors have prompted investors to buy inflation-protected T-bills, whose payments rise to keep pace with inflation, and to sell regular T-bills.

The difference between the yields of these two types of bonds is called the breakeven point, and it offers a rough estimate of what those who invest in the more than $ 20 trillion treasury bond market thinks it is. it will arrive at the prices. As of Tuesday afternoon, the five-year breakeven point was 2.98%, according to data from bond trading platform Tradeweb.

Investor opinion matters a lot. For decades, the Federal Reserve’s decisions about what to do with interest rates and monetary policy have been heavily influenced by the idea that inflation is as much a psychological process as it is an economic one. Expectations of rising inflation can become a sort of self-fulfilling prophecy, so that the Fed has been inclined to raise interest rates or tighten monetary policy when public opinion anticipates higher prices. students.

Many analysts expect the Fed to react the same this time around, even if an interest rate hike might not be the first step.

Before that happened, the Fed would end the extraordinary measures it has taken to protect the economy from the worst of the pandemic. This process is widely expected to begin at the Fed’s meeting next week, when its main monetary policy committee is likely to start cutting back on bond buying programs that have injected $ 120 billion into financial markets each month since. start of the pandemic. It’s unclear how quickly the Fed would end this program, but investors now appear to be betting that it could be phased out by the middle of next year.

In recent days, the market-based odds of a rate hike at the Fed’s June 2022 meeting have jumped to around 60%, according to CME data. It was around 15% at the start of the month.

Investors are closely watching the Fed’s movements. Bond buying programs and low interest rates have been a huge boon to the stock market; the S&P 500 is up more than 100 percent since they started, including a gain of around 22 percent this year.

But some on Wall Street believe the markets could accept a methodical change by the Fed in interest rates, especially if it means controlling inflation.

“I think as long as you move away from the emergency conditions on purpose, the markets will like this and the growth can continue., ” said Rick Rieder, head of the global allocation investment team at fund management firm BlackRock.

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