U.S. Inflation: The Bond Market Weighs In

Mid Week Bond Update

U.S. Inflation: The Bond Market Weighs In

Signs of economic strength are plentiful. But the inflation outlook is pulling back – at least according to the market for U.S. Treasuries.

Signs of economic strength are plentiful, with Q2 GDP up an annualized 4.2%, personal consumption up 4.0%, June core consumer prices up 2.3%, July’s unemployment rate stable at 3.9% and job openings for June measured at 6.66 million.

But instead of rising apace, the outlook for inflation is pulling back – at least according to the market for U.S. Treasuries.  Breakeven inflation rates, which are indirect measures of the Treasury market’s expectations for rising prices, show those expectations have been moving downward slightly for the five years ahead, and are now just below the Fed’s 2% objective.  And the nearer-term 2-year breakeven rate is now about 1.75%, after having been above 2% as recently as the end of March 2018.


Source: Bloomberg, August 7, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


These readings are consistent with the Fed’s preferred measure, Core Personal Consumption Expenditure inflation, which will be released toward the end of the month. It appears that the Fed may concur with this assessment. In the statement accompanying the FOMC decision to leave its target rate at 2.0%, core inflation was described as remaining near 2%, rather than rising.

Breakeven rates aren’t predictions; instead, they reflect each day’s changeable expectations about the future. But the signal they’re sending about today’s expectations are clear nonetheless.

On the rise: U.S.  Investment-Grade Energy Debt

The energy sector of the bond market is dominated by offerings in the high-yield space .  But investment-grade energy has attracted notice as well recently. Over the past three months, the sector has handily outperformed both the Bloomberg Barclays U.S. Aggregate Index and  Corporate (investment grade) Index in terms of total return: While the U.S. Aggregate Bond Index rose 0.70% during the three-month period ended August 7, 2018, the U.S. Corporate Index rose 1.18% and the S&P U.S. Investment Grade Corporate Bond Energy Index returned 1.57%, 39 basis points better than the general investment-grade index.

Of course, gains over  such a short period might not be indicative of long-term differential return. But these results line up with the overall good news in the U.S. Energy sector, where balance sheets have been bolstered over the past few months by rising energy prices – and which have been used by companies in the sector to pay down debt and take advantage of already-built exploration, production and transportation infrastructure.


Source: Bloomberg, July 31, 2018. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


On the slide: Turkey Sovereign Debt

As of the end of the trading day on August 7, bids for Turkey’s 5-year government debt were running at about 21%, up dramatically from the 11.88% yield at the start of 2018 – despite the attempt by the central bank on July 17th to arrest the rise in yield and plummeting  value Turkish lira. The lira itself, as of August 7, traded at 5.258 per U.S. dollar,  having pulled back from its low of 5.422 per dollar on August 6th in reaction to a sale of U.S. dollar swaps by the Turkish central bank.

In this situation, the typical reaction of a country’s central bank would be to ratchet up its main policy interest rate; appeal to the International Monetary Fund (IMF) for emergency relief; and/or  impose capital controls as a last resort. However, the matter is complicated by Turkey’s bitter policy dispute with the EU and the U.S. over Syria, refugees, the detention and trial of American pastor Andrew Brunson;  and dueling economic sanctions.

The IMF hadn't received a request for assistance as of the close of business on August 7; Turkey's central bank has made no policy changes; and there have been no statements from either the president’s office or from the central bank about the current situation.

Indeed, the central bank, whose administration is widely perceived as an ally of the newly re-elected government, has instead clearly stated that it will encourage low interest rates to stimulate growth.  A Turkish trade delegation is scheduled to meet with U.S. trade officials in Washington this week, which could break the logjam  on at least some of these issues.

Meanwhile, advocates of central bank independence now cite Turkey as a cautionary tale worth watching.


All data Source: Bloomberg August 7, 2018, or on their respective indicated dates.


An implied breakeven rate is a measure derived from comparing returns of two classes of securities whose value depends on the same factor, such as inflation or default rates.

The 2-year and 5-yearbreakeven inflation rates are measures of expected inflation derived from nominal Treasury securities and their inflation-adjusted counterparts—inflation-protected TIPS securities.

The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index that measures the performance of the investment grade universe of bonds issued in the United States. The index includes institutionally traded U.S. Treasury, government sponsored, mortgage and corporate securities.

The Bloomberg Barclays US Corporate Bond Index measures the investment grade, fixed-rate, taxable corporate bond market. It includes USD-denominated securities publicly issued by US and non-US industrial, utility and financial issuers. The US Corporate Index is a component of the US Credit and US Aggregate Indices.

The  S&P U.S. Investment Grade Corporate Bond Energy Index measures the total return of investment-grade bonds in the energy sector.





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