When investors get scared, they tend to rush for safe-haven assets, with the one at the top of the list being the 10-year Treasury Note.
The problem is that holding U.S. Treasuries is starting to look increasingly risky, rather than safe.
Inflation Getting Ready to Bounce Back
The problem is that an imminent surge in inflation will drive bond yields higher and so push the price of the securities down, according to a recent report from The Leuthold Group, LLC.
The10-year bond was recently yielding 0.7%, according to data collated by Ycharts. That yield fell from more than 3% in late 2018.
But now Leuthold thinks that inflation will push yields back up sending bond prices down. Bond prices move inversely with yields.
“Since March, the inflation outlook has slowly, but persistently, climbed while the 10-year bond yield has trended sideways,” writes Jim Paulsen is chief investment strategist at Leuthold. “This cannot continue indefinitely.”
Or put another way, rising expectations of inflation will lead bond investors to demand higher yields to tempt them into buying the fixed-income securities.
Investors Wont Tolerate Negative Real Yields
Part of the issue is that it won’t take much of an increase in inflation, from its recent rate of 0.1%, to make the inflation-adjusted or real yield on the 10-year negative. Negative real yields mean investors aren’t keeping up with inflation.
The Leuthold report also highlights the fact that inflation readings have been coming in higher than expected. The report cites the Citi Inflation Surprise Index, which shows that “U.S. inflation surprises have surged to their highest level since 2010!”
Get Ready for Treasuries to Get Hit Hard
That surprising rise in inflation will no doubt be exacerbated by the government spending and bond-buying programs by the Federal Reserve. In simple terms, inflation is on the way back, and that will hit bonds hard, as the Leuthold report explains.
- “Ultimately, bond yields will not only have to catch up to rising inflation expectations but also re-establish their normal, positive inflation buffer. That is, at some point, bond yields are almost assured to rise “more” than inflation expectations.”
When those bond yield rise more than expected inflation, then Treasuries and other high-quality bonds will tank.
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