De Gaetano Andrea Analista indipendente BondWorld

BondWorld : Treasury rally

BondWorld : Treasury rally on flight to quality and accommodative central banks, despite jump in US inflation

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Andrea De Gaetano – Independent Analyst

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Equity declines on fears of new Covid variants and rising contagion.

US Treasuries rallied, supported by accommodative central banks, flight to quality and falling oil prices, following the OPEC agreement to increase production by 2 million barrels per day (400,000 barrels per day, per month) from August to December. 

The US 10-year yields 1.29%. The German 10-year yield -0.35%. The 10-year BTP yields 0.70%.

Appreciation of the dollar and yen.

In June, US inflation recorded the strongest increase over the previous 12 months since August 2008. It rose 5.4% year-on-year and 0.9% from the previous month, following a 0.6% jump in May. Used car and truck prices continued to climb with a 10.5% increase in June and +45.2% year-on-year. This increase weighs more than a third on the index of ‚all items‘ inflation.

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US inflation June 2021, Source US Bureau of Labor Statistics

Positive surprises came from US retail sales, up 0.6% in June compared to the previous month and up 18% compared to June 2020.

Powell used accommodative tones in his hearing before the US Congress last week. Inflation will remain elevated in the coming months before moderating and the Fed will continue to support the economy until the recovery is complete, the US central bank president said.

In Europe, inflation fell to 1.9% in June from 2% in May.

The ECB will have one more reason to be accommodative at its next meeting on Thursday 22 July.

Christine Lagarde, in an interview with the Financial Times on 13 July, anticipated the first review of the ECB’s monetary policy since 2003.

The „lower but close to 2%“ inflation target will change to a „simple, solid, symmetric 2% target“. Whereas in the early 2000s the ECB was terrified of inflation, today it would like higher inflation. It will probably follow in the Fed’s footsteps, letting inflation exceed the 2% level before reducing securities purchases or raising rates.

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M3 United States, Source Federal Reserve St. Louis

Central banks argue that inflation is temporary, due to „bottlenecks“ in supply and the rapid increase in demand with reopenings, which should balance out over time.

But the money supply exploding to unprecedented levels suggests that inflation will be less temporary than central banks say. If it moderates in the coming months, it will still remain at levels incompatible with zero Fed Funds rates.

By way of comparison, in 2007 with inflation levels similar to today, US rates were between 4.75% and 4.25% and in 2008 they fell with the bursting of the subprime mortgage bubble from 3.50% in January 2008 to 0-0.25% post-Lehman in December 2008.

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US inflation June 2001-June 2021, Source US Bureau of Labor Statistics

Tactically, any further fall in 10-year Treasury yields to 1.10-1.20% will be a selling opportunity.

Then we will need to start paying attention to short-term maturities, whose yields will be the next to rise.

US quarterly reports are off to a good start, but the timing will be dictated by the evolution of the pandemic and consequently by central banks.

Meanwhile, we await news from the ECB on Thursday 22 July.