The US Treasury Market’s Reaction to Inflation Reports

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While inflation has surged to levels not seen in more than three decades, investors in the government bond market seem to accept the Federal Reserve's argument that inflation will not stick around.

Federal Reserve Chairman Jerome Powell has argued for months that the rise in inflation is transitory, caused by ongoing supply chain challenges amid post-pandemic rising demand. The bond market has, so far, agreed, with long-dated bonds not running up alongside inflation. Yields in shorter-duration treasuries increased while longer-dated bond yields dropped. (See chart)

The short duration US Treasury yields, including the 1-year, 3-year and 5-year, have seen significant increases over the past month. In contrast the longer duration treasuries, like the 20- and 30-year bonds, have decreased over the past month, flattening the yield curve even further. (See chart)

Bond yields move inversely to prices, with a rising yield signifying declining demand for bonds. Yields tend to rise during periods of high growth and inflation, but the decline in long-dated bonds suggests the market anticipates inflation will be short-lived.

According to some Federal reserve sentiment measures, expectations of multiple Fed rate hikes in 2022 have sharply increased. These expected hikes are keeping longer bond yields down. The bond market indicates that the Fed and other forces will be able to tame inflation longer term. We have included inflation protection bonds in our fixed income allocation to address the hopefully short term but dramatic change to inflation interest rates.

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