June 10, 2021 | By Hank Cunningham
here is a great divide in inflation forecasting. A large contingent of forecasters, led by the Fed and the Treasury Secretary, believe the current pickup in inflation is transitory and that it will subside after the long-term deflationary factors such as demographics, technological advancements and debt kick in. Another camp views the combination of massive monetary and fiscal accommodation, along with a tight employment market and rising wages, as a cyclical phenomenon and one which will produce higher yields.
The Fed, despite its transitory stance, is tip-toeing towards the first reduction in its bond-buying program. No less than five Fed officials have been quietly espousing a move towards tapering and it was likely discussed at the recent FOMC meeting. Chair Powell will proceed cautiously.
The economic recovery will continue to accelerate and move past pre-pandemic growth levels. It is difficult to see how bond yields can fall from current levels with the ten-year yield substantially below the inflation rate. The recent fall in bond yields may be one more example of “not fighting the Fed.”
At the margin, bonds are expensive and their yields could creep higher, with 2% as a target on the U.S. 10-year Treasury. Credit markets remain healthy. Investors can look forward to modest positive returns.