Is the bond market wrong about inflation?
The bond rally suggests that markets are sanguine about inflation, but the gold rally suggests inflation is a real threat.
US GDP had its worst fall on record in the second quarter. It shrank by 9.5% from the previous quarter, a 32.9% slump in annualised terms. “That is... the equivalent of the first three years... of the Great Depression accelerated into just three months”, says Tim Price of Price Value Partners.
GDP is a backward-looking indicator, but US weekly jobless claims have increased for two weeks running as the virus has forced renewed closures in southern states, says Alexandra Scaggs for Barron’s. The bond market is now sending a “warning signal” about the recovery, says Giles Coghlan on fxstreet.com. The yield on US ten-year Treasury bonds hit its lowest level since early March last week, while three- and five-year yields hit new record lows. Bond yields move inversely to prices, so falling yields imply gains for bondholders.
The bond rally is perplexing for two reasons. Firstly, governments have issued vast tranches of new debt to pay for the pandemic, which would ordinarily cause their borrowing costs (implied by bond yields) to rise, not fall.
The US budget deficit hit $864bn in June, a figure Dan Morehead of Pantera Capital says surpasses “the total [US state] debt incurred from 1776 through the end of 1979” in nominal terms. In 2020 a country can rack up “two centuries of debt in one month”. Bondholders have central-bank purchases to thank for keeping yields low.
Secondly, the bond rally suggests that markets are sanguine about inflation, says Tommy Stubbington in the Financial Times. That’s partly because monetary stimulus after the financial crisis did not deliver the inflationary wave many predicted. Yet the recent gold rally suggests that concern about rising prices is growing. If the gold buyers are right, the bond market has got it “very wrong”.