One of the most powerful US bond managers has warned of an “inflation head fake”, where misplaced concerns about a rise in consumer prices cause a jump in bond yields.
The comments by Dan Ivascyn, chief investment officer at Pimco, which has $2.2tn under management, come after long-dated US Treasury yields climbed to their highest level in a year.
The dramatic move reflects expectations of a robust economic recovery, further fiscal stimulus from Joe Biden’s administration and the willingness of the Federal Reserve to tolerate core inflation running above 2 per cent.
“There is a material risk for the bond market of an inflation head fake,” Ivascyn told the Financial Times in an interview on Tuesday. “This could be a powerful recovery and we have never gone from locking down an economy to opening it back up with this amount of stimulus.”
Pimco expects any inflation pick-up will prove temporary, but “the bond market may not come to that conclusion in the near term”, Ivascyn said.
Inflation will remain contained because of long-established trends such as technological innovation cutting costs and the weakness of organised labour, Pimco has argued. Slack will also linger in the labour market due to high unemployment, Ivascyn said.
“We still see powerful disinflationary trends. After an initial recovery [from the pandemic] there is likely a world of excess capacity,” he said.
As the pandemic hit the global economy last spring, the Fed’s preferred measure of annual core inflation briefly fell below 1 per cent, from 1.65 per cent a month earlier. Even after a rebound it remains below the US central bank’s target of 2 per cent.
However, expectations for the average level of inflation over the next decade, as derived from bond prices, have risen to nearly 2.2 per cent, the highest level seen since 2014, reflecting in part surging commodity prices.
Inflation erodes the value of the interest payments on bonds, and dents the debt’s value, so these nerves have tipped global government bond markets into their weakest start to a year since 2015. The yield on the benchmark 10-year US Treasury breached 1.4 per cent on Wednesday, having started the year at about 0.9 per cent. Yields rise when prices fall.
Yields remain low by historical standards. But the fact they have been so low over the past year has provided a key support for stocks, which have rushed higher over the past 11 months. As they pick up, particularly real yields that are adjusted for inflation, investors fret that some of the frothier corners of the stock markets are left vulnerable. Rising real yields have already been a factor in a 4 per cent drop in the technology-heavy Nasdaq index since mid-February.
“The back-up in rates has been healthy,” Ivascyn said. “A further rise in real yields would hit risk assets like equities and see policy adjustments.”
He predicted that the Federal Reserve could intervene if the rise in yields accelerates. This would more likely take the form of strong statements designed to hold down long-term rates, rather than policy changes such as buying long-dated bonds to control yields.
“I don’t believe yield curve control is around the corner [but] we may get the type of rhetoric that seeks to achieve that policy goal,” he said. A rise in 10-year yields beyond 1.5 per cent would represent a “good buying opportunity for investors”, he added.