The reflation trade — the darling of Treasuries investors betting on rebounding growth — is proving resilient.
One of the hot wagers of 2021 barely lost a beat this week even after a surprisingly soft report on consumer prices. Long-term Treasury yields touched the highest in almost a year, market proxies of inflation expectations accelerated to the fastest pace since 2014 and the yield curve tested the steepest levels in more than five years.
The message is that investors still see additional fiscal stimulus as a lock and are banking on the vaccine rollout gaining momentum. The coming week’s auction of 30-year inflation-linked Treasuries stands to give a fresh test of just how much investors fear rising price pressures down the road as the economy reopens.
“The confluence of more fiscal support and the reopening of the economy hitting together around springtime is lifting the outlook for inflation and growth,” said Ben Emons, managing director of global macro strategy at Medley Global Advisors. “Rising breakevens and the steepening yield curve show that some people are trading already on the future economy — post the pandemic.”
The benchmark 10-year yield eclipsed 1.2% on Friday, touching the highest since the market chaos of March. Thirty-year yields are right around 2% — the highest since February 2020. Their gap over 5-year rates was about 152 basis points, near levels last seen in 2015.
Take a Breather
The reflation trade took a brief pause after a government release on Feb. 10 showed the pace of core consumer-price inflation was 1.4% annually, lower than expected. The week ahead brings producer-price figures, which are expected to show subdued pressures.
While the CPI report “was a disappointment, it does not change our outlook and we do not expect it will change investors’ views about expected reflation,” Michael Pond, global head of inflation-market strategy at Barclays, wrote in a note. “The reflation theme is based on a story about where inflation will go once most are vaccinated and demand normalizes.”
It’s also a theme that the Federal Reserve has been encouraging, with its signals that it wants inflation to average 2% over time, and that it intends to maintain its ultra-loose monetary policy for the foreseeable future.
Retail investors for their part have been snapping up products that hedge inflation risk. They’ve been adding money to the iShares TIPS ETF, the largest exchange-traded fund featuring Treasury Inflation-Protected Securities.
Survey-based measures of the inflation outlook are also edging higher. On Friday, the University of Michigan consumer sentiment poll showed the median expectation for inflation in the year ahead rose to 3.3%, the highest since 2014.
What to Watch
- The Treasuries market will be closed Monday for a U.S. holiday. Below are the calendar highlights.
- The economic calendar:
- Feb. 16: Empire manufacturing; Treasury International Capital flows
- Feb. 17: MBA mortgage applications; produce price index; retail sales; industrial production; business inventories; NAHB housing index; FOMC minutes
- Feb. 18: Building permits; housing starts; jobless claims; import/export price indexes; Philadelphia Fed business outlook; Bloomberg consumer comfort
- Feb. 19: Markit U.S. PMIs; existing home sales
- The Fed calendar:
- Feb. 16: Fed Governor Michelle Bowman; Kansas City Fed’s Esther George; Dallas Fed’s Robert Kaplan; San Francisco Fed’s Mary Daly
- Feb. 17: Richmond Fed’s Thomas Barkin; Boston Fed’s Eric Rosengren; FOMC minutes
- Feb. 18: Fed Governor Lael Brainard; Atlanta Fed’s Raphael Bostic
- Feb. 19: Barkin; Rosengren
- The auction calendar:
- Feb. 16: 13-, 26-week bills; 42-, 119-day cash management bills
- Feb. 17: 20-year bonds
- Feb. 18: 4-, 8-week bills; 30-year TIPS