Market Extra: Why the ‘inflationistas’ likely will get it wrong over the long run, says this fixed-income investor
Don’t get too comfortable with 10-year Treasury yields near 1.6%, warns Michael Collins, senior portfolio manager at PGIM Fixed Income, which oversees about $954 billion in assets globally.
Instead, he sees the recent spike in the long-term U.S. government bond rate as likely the second of two “twin peaks” this year for the benchmark.
“When it got to 1.75% in March, we through it was extremely high,” Collins said of the 10-year Treasury yield
in a phone interview. “Now, you are kind of at the point where it’s probably again close to the high-water mark.”
Collins attributed this year’s earlier Treasury-yield climb to the “reopening euphoria” that followed pandemic shutdowns and an initial “pop” in global growth. More recently, 10-year government bond yields have moved higher again, in part, as Federal Reserve Chairman Jerome Powell has expressed frustration with prolonged supply-chain bottlenecks and inflationary pressures that could stick around for longer than initially anticipated.
The benchmark 10-year Treasury rate rose almost one basis point on Monday to 1.583%, or about 17 basis points below its high this year of 1.749% set on March 31, according to Dow Jones Market Data.
“If we get to 2%, back up the truck and add duration aggressively,” he said of the 10-year yield, adding that PGIM already has been adding duration at current yields.
That’s mainly because PGIM expects the secular trends of an aging global population and workforce to prevail eventually, causing the world’s biggest economies to see slower growth over the long haul.
“That’s a very different picture of the world than you might hear from talking heads,” Collins said, adding that the PGIM fixed-income team “couldn’t be in a different camp” from those insisting that U.S. inflation will stay above the Fed’s 2% annual target for an extended period.
“Inflationistas want to chase this thing,” he said, pointing to calls within the Fed to more quickly reduce its $120 billion pace of monthly bond purchases, but also expectations on Wall Street that the central bank could embark on a more aggressive pace of increases to short-term policy rates in an effort to tamp down stubbornly high costs of living.
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Chris Wu, a portfolio manager at Federated Hermes, said there are “reasons to believe inflation risks are to the upside,” in a client note circulated Monday.
He argued that inflation possibly can run hot “for a lot longer than some investors think,” partly because it remains unclear how far backward the Fed’s new flexible average inflation target looks when computing the long-term average.
“10 years? 5 years? This matters because the longer the Fed looks back, the longer it could let inflation run above 2% without feeling compelled to start reining it in,” Wu wrote. Federated Hermes oversees about $650 billion in assets.
Even so, a slowdown of the earlier breakneck pace of economic growth appears to be happening in China, where the third quarter saw 4.9% growth, down from 7.9% in the quarter before. Goldman Sachs economists earlier this month also cut their U.S. economic growth forecasts for 2021 and 2022, in part due to a lagging recovery in consumer spending.
To be sure, demand for goods has run hot as the COVID threat has faded in parts of the world. But the desire to buy things also comes as global supply chains remain tangled and commodity prices have climbed, including oil, which saw the U.S. benchmark West Texas Intermediate crude future
settle above $82 a barrel on Monday, or not far off levels last seen in 2014. Higher commodity prices can act as a tax on economic growth.
Despite the uncertain backdrop, U.S. stocks closed mostly higher Monday, with the S&P 500
and Nasdaq Composite
extending their win streaks to four straight sessions, the longest such stretch in nearly two month. The Dow Jones Industrial Average
Read: Why soaring oil prices could soon make the stock market sputter