A just-published report revisited the unique macro and bond market environment 40 years ago. The report concluded that a thorough understanding of the evolution in investor perceptions and bond market pricing during the 1980s’ shift in the secular inflation trend will prove valuable for investment strategy in the years to come.
It is common for investor expectations and market pricing to persistently lag economic fundamentals at secular turning points. Indeed, the U.S. Treasury market is now rhyming (inversely) with the early- to mid-1980s. Policymakers and bond investors tend to abandon their macro frameworks at secular turning points in consumer price inflation, which allows the latter to become a leading variable for financial markets. Disinflation was viewed as “transitory” in the early-1980s, and the same is true for the rise in inflation to well above 2% this year.
U.S. Treasurys are not yet an attractive buy-and-hold investment since longer-term inflation expectations remain too low and bonds are not undervalued. However, the 1980s’ episode also warns that bond yields could briefly drop more than justified whenever measured inflation subsides. We are currently in such a period. Thus, while we are structurally bearish on U.S. Treasurys, periodically one needs to make tactical bullish bets to generate decent returns over the cycle, as we have done in the MRB TradeBook.