The topic on investor’s minds last week was concerns over a sudden rise in inflation expectations. Bond yields rose as prices plunged (bond prices and yields move inversely) and the broad major stock indexes pulled back. The selloff was most notable in the tech-heavy Nasdaq as investors shifted toward companies that will benefit from a faster growing economy; namely, airlines, hotels and other travel-related businesses. The Nasdaq closed down almost 5% on the week.
To gauge how serious inflation threats might be, we examine the spread (difference) between the yield on the five-year treasury and the yield on inflation-protected Treasurys known as TIPS. The difference is called the “break-even rate.” With last week’s action in the bond market, that break-even rate rose to 2.4%, the highest level since May 2011. This suggests inflation is going to rear its ugly head.
But there is more going on below the surface. Short-term interest rates have spiked above long-term rates. This is called an “inversion” and typically forecasts a sharp spike in inflation that quickly falls away.
To summarize: the five-year break-even rate is 2.4%. The ten-year rate is 2.15% and the longer 30-year break even rate is 2.1%. The five-year break-even rate hasn’t been above the ten-year rate since 2008. Put this all together and most analysts expect this sudden burst of inflation to evaporate. Even Federal Reserve Chairman, Jerome Powell said the central bank isn’t about to alter its monetary policy. What more could you ask for?
The chart below from the Wall Street Journal is difficult to see but if you look closely you will notice the yield on 5-year treasuries is higher than the 10-year. That type of event doesn’t last long.
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The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.
Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
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Note: All figures exclude reinvested dividends (if any). Sources: Bloomberg, Dorsey Wright & Associates, Inc. and The Wall Street Journal. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.
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