Inflation has become the cause celebre in today’s bond market. With additional federal stimulus enacted, a very ambitious infrastructure program on the table, and the Federal Reserve still providing highly accommodative monetary policy, 2021 began with investors becoming increasingly concerned about the risk of a prolonged inflationary environment. With an assist from widespread vaccinations and with the “re-opening trade” in full gear, rates rose early in the year as a result.
But during the second quarter, bond markets seemed to do an about face, even though inflation data routinely exceeded market expectations. CPI, PPI, GDP price index, and Core CPI all registered significant gains, including a core CPI reading in May that was the highest in 40 years. Remarkably, the 10-year Treasury yield declined by 3 basis points (bps) over the quarter and 30-year rates fell by 12 bps. With rising inflation and falling nominal yields, real yields were decidedly negative. Economists began to ratchet down their year-end interest rate projections; greater than 2% had been a common projection early in the year, but by mid-June, the Bloomberg survey median was down to 1.88% and likely falling.