On the Long Bond and Why the Widow Maker is Alive and WellFebruary 27, 2015
Perhaps one of the most important questions investors need to answer today is whether we’ve seen the low in the long bonds yields or whether the trend lower is firmly intact. The recent spike in the 10-year bond yields from 1.65% at the end of January to 2.14% just two weeks later has no doubt complicated the situation. In this piece we’ll try to layout one case for lower yields still.
As the first chart below shows, bond yields have spiked higher over the last few weeks, but the trend lower has hardly been compromised thus far. Chart two shows that the rise in breakeven inflation expectations played a large role in the rise in rates, but real rates (TIPS) yields (blue line, left axis, inverted) actually rose as well. This tells us that the rise in yields has been due to a rerating in both growth and inflation expectations. The question is whether this is a cyclical rebound from excessively deflated expectations or whether growth and inflation are actually picking up. We have something to say about both.
As the following three charts show, inflation is clearly not picking up. The first two charts show the Citi Inflation Surprise Index for developed and emerging markets, respectively. Both are headed lower. This confirms the trend lower in actual inflation readings as shown by our proxy of world CPI in the third chart. Indeed, actual realized CPI is at the lowest level since 2009.