The bond market is sounding the alarm that the flood of cash that policy makers have unleashed to buoy growth in the face of the pandemic will have potentially painful consequences for the economy.
The Treasuries yield curve is the steepest in three years, with long-maturity rates climbing as the Federal Reserve prints billions of dollars a week to add to its stockpile of government debt and other assets. The steepening phenomenon is typically a signal of improving growth prospects, and riskier assets such as stocks are certainly rallying. Yet some investors are more wary about what it says about inflation expectations, with U.S. activity merely giving a hint of bottoming out from what’s likely the deepest slump in living memory.
The risk that the market is starting to grapple with is that in the pandemic’s wake, stagflation -- a troublesome combination of tepid growth and accelerating inflation -- takes hold in the years ahead and vexes markets as it did in the 1970s. Cash is flooding into funds that invest in inflation-protected securities, and breakeven rates, another gauge of consumer-price expectations, are ticking back higher.
Not that this is all bad, necessarily. The Fed would actually welcome a move away from the deflationary angst that took hold at the peak of the market turmoil in March, as its unprecedented monetary easing is aimed at doing just that. Yet the prospect that inflation will quicken at the same time that job creation sputters is far from ideal. With most bond investors braced for low rates for years to come, the specter of yields finally taking flight could prove perilous.
“The Covid-19 crisis will be remembered for many things, and among them will be the long-awaited return of inflation in developed markets,” said Oliver Harvey, a macro strategist at Deutsche Bank AG.
In a world of zero rates, inflation may seem like a distant threat -- and those who worry about it are a minority in the market, with inflation prognosticators having been proven wrong time and time again over the past decade. But it may be the side effect of the pandemic cure being administered by central banks and governments.
The Fed’s balance sheet alone has swelled above $7 trillion from about $4 trillion in early March, and more steps may be coming, such as yield-curve control. Expectations for such a move are contributing to the steepening push.
For Scott Minerd, chief investment officer at Guggenheim Investments, the Fed’s programs propping up the corporate bond market will lead companies to become even more leveraged, reducing productivity and crimping growth.
Corporations’ reliance on Fed support means the central bank will “have to continue providing liquidity to the system until inflation rates pick up to levels that probably would be viewed as unacceptable by most participants of the Fed today,” Minerd said on Bloomberg TV Wednesday. The long-run implication is “a period of stagflation.”
‘Apocalypse Scenario’
The steepening yield curve, coming as equities are surging, looms large on the radar of Kathryn Kaminski, chief research strategist and portfolio manager at AlphaSimplex Group. For her, it warns of growing concern about inflation, a topic she says she’s hearing more buzz about.