A just-published report examined Fed policy and the outlook for Treasury yields, and reiterated that a bearish investment stance is warranted. There has been a massive divergence between (depressed) real bond yields and rising breakeven inflation rates, which we view as a serious warning sign for investors. The last time such a divergence occurred was preceding the 2013 taper tantrum episode, which led to a surge in Treasury yields and a reconvergence of the underlying components as real yields moved sharply higher.
Bizarrely, although the Fed has significantly upgraded its economic forecast this year, it continues to anticipate no change in core inflation. Price pressures will not be as transitory as the Fed and many investors currently expect. Rather, we anticipate that core consumer price inflation will be sticky above the Fed’s target next year. This, in turn, will be a catalyst for higher real and nominal bond yields.
We remain underweight U.S. Treasurys and short duration in global fixed-income portfolios, and continue to favor inflation-protected bonds. Also, we remain underweight bonds in multi-asset portfolios.