Unlike Other Experts, Bond Traders Know What They're Doing 😉

Bond traders: the guy is just there to keep the
algorithms' screens clean (joke). (Reuter's image)

We started worrying about inflation in February.

In May the recovering economy combined with stimulative fiscal ($trillions) and monetary policy--looked like we were headed for a reprise of the inflationary 1970's.

However, one group of very smart people is keeping us from making an unequivocal declaration about future inflation: the bond traders. WSJ columnist James Mackintosh: [bold added]

The core of the problem is that as inflation soared, bond yields fell, creating an instant contradiction: Inflation is poison to bond investors, so they would normally be expected to sell. I have an explanation, but it isn’t perfect.

My take: Investors came to the realization that the huge post-pandemic debt burden will keep rates lower than in the past, while they kept faith that inflation will be manageable. There is little to indicate investors fear a recession-inducing mistake by the Federal Reserve, and they aren’t expecting runaway inflation either.

More conundra:

it is deeply strange that stocks should reach new highs both when bond yields were falling (and stocks were driven by Big Tech) and when bond yields were rising (and stocks were led by cyclicals).

And there is one more oddity that is far harder to understand: By Aug. 3, yields on 10-year Treasury inflation-protected securities, or TIPS, reached minus 1.2%, the lowest point for inflation-adjusted yields in history. It could only make sense if investors were expecting stagflation, or weak economic growth combined with higher inflation. But if the risk of stagflation were rising, investors should be buying gold—which usually rises when TIPS yields fall—and dumping the junkiest corporate bonds, as defaults would be sure to rise. Instead, the relationship between gold and TIPS broke down, while junk bond yields rose only a little from what had been close to record low spreads over Treasurys.

As for your humble blogger-investor, my fear of losing purchasing power due to inflation outweighs my desire for outsized gains from hot stocks.

So I'm nibbling just a little on hard assets, and taking some profits off the table (not enough to push us into a higher tax bracket).

So not much buying or selling this year. Through sad experience I've found that making big moves in confusing times--and I'm not just talking about financial markets--doesn't work out well.