Latest Rise In 10-Year Yield Stirs Reflation Forecasts… Again

By James Picerno, Director of Analytics

It doesn’t take much to set reflation expectations on fire these days. With US interest rates near zero (or negative in some parts of the world), a mild uptick in yields inspires a new round of forecasts that a sustained run of higher inflation has finally started.

No wonder, then, that the recent jump in the 10-year rate stoked inflation fears in some circles. The benchmark yield rose to 0.78% (Oct. 5), based on daily data. That’s the highest since mid-June.

The reflation alarm is a bit stronger by way of the 30-year yield, which rose to 1.57%, which is also the yield’s 200-day moving average. The last time the two matched was March 2019, and so by this definition the upside bias seems to have a bit more oomph.

By some accounts, the stars are aligning for stronger pricing pressure, thanks to a combination of 1) the likelihood that government fiscal policy will remain more active on the stimulus front and 2) extraordinary dovish monetary policy that’s desperately trying to drive up inflation.

The annual pace of core inflation for consumer prices is currently 1.7% through August, which is low by historical standards, but higher than June’s 1.2% pace. Is this the start of the reflation revival?

Possibly, but Lance Roberts at Real Investment Advice recently reminded that the Federal Reserve has been trying (and failing) to lift inflation for more than a decade.

“For the last 12-years, this belief has remained a constant in the market,” Roberts writes. “It stems from the idea that increasing the money supply is inflationary as it decreases the value of the dollar. There is indeed truth in that statement when considered in isolation. However, when the money supply is increasing, without an increase in economic activity, it becomes deflationary.”

The future, of course, is full of surprises and so no one should assume that ongoing disinflation/deflation, higher inflation or something in between is off the table. Stuff happens. But years of weak growth, low inflation and relatively ineffective monetary policy to change the trajectory aren’t likely to reverse course overnight.

Reversals do happen and when it begins the warning from the proverbial canary in the coal mine will likely be a sustained rise in Treasury yields. The latest uptick is far from definitive proof, but perhaps it’s a start… or just more noise on the path to even lower rates.

(An earlier version of this article first appeared at The Capital on October 6, 2020.)

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