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U.S. Inflation: A Reprieve For Bonds? – May 16, 2022

A just-published report highlighted the increased prospects for a period of calm in the Treasury and global bond markets. The relentless rise in U.S. inflation has crested, as the surge in goods inflation has peaked. This, plus (misplaced) angst about a looming recession, should cap bond yields and perhaps even trigger a countertrend decline.

Looking ahead, however, the trend in U.S. services inflation is a mounting concern, and is now contributing more to core CPI than goods inflation, even though service sector activity has not yet fully re-opened. Moreover, service sector inflation tends to be stickier than goods inflation, especially in important components like rent. Higher service sector inflation has already leaked into rising wage demands and inflation expectations, and these latter trends are difficult to reverse absent much weaker demand.

We remain cyclically bearish on bonds, as government bonds are still overvalued (even after the rise in yields over the past year or so), and have further to adjust to reflect the new higher underlying inflation world. Thus, any easing in bond yields should be seen as a countertrend move, rather than the end of the bear market.