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Worried About Rising Treasury Yields and Inflation?

3/30/2021

Many investors have begun to worry about inflation.

Yields on 10-year bonds surged to 1.7% from 0.91% at the beginning of the year. While rising yields can portend rising inflation, yields on Treasuries remain below inflation. Zero or negative “real yields” (after-inflation) do not suggest concerns about accelerating inflation. Yet, government influence renders these tea leaves almost meaningless.

The Federal Reserve is buying about $1 trillion of Treasury bonds annually, funding about 40% of the budget deficit in Fiscal 2020. The Fed has its thumb on the scale of interest rates, so how do we determine the true market-clearing yield? We can’t, and this is troubling because Treasury yields serve as the reference rate for most other interest rates, including mortgage rates and corporate bonds. False signals are sent throughout the economy.

Fed Chairman Jerome Powell acknowledges that inflation could rise temporarily due to the anticipated burst of spending this Spring, but that it shouldn’t reach “troubling levels.” Let us hope he’s right, but like many situations over the past 12 or so months, this too is “unprecedented.”

It is said, “the stock market runs from uncertainty.” This implies renewed volatility, but the spending surge will increase profits broadly and investors like rising profits! Perhaps this explains why the market is at an all-time high despite numerous sources of uncertainty acknowledged by most investors. But we must not freeze in fear. Not deciding is still a decision—a default decision to accept the status quo.

It seems prudent to hold on to some cash in case great opportunities emerge, but to remain largely invested as long-term stock prices follow earnings and earnings are likely to be favorable.


Reprinted from the April 2021 issue of the Investor Advisory Service. For more information, to download a sample issue, or to subscribe to the best investing newsletter in the U.S., visit Investor Advisory Service.