Ten-year US Treasury yields have reached their highest level since 2011, 3.09%, breaking out of the three-week range. A solid retail sales release – with a 0.3% gain in April and an upward revision to 0.8% in March – rekindled concern that inflation will accelerate, contributing to the selloff in bonds.
While we will be monitoring inflation trends carefully, we believe such worries are overdone at present:
- We expect the headline consumer price index (CPI) to trend higher toward a peak of around 3% year-on-year over the summer. But this is largely due to base effects – notably last year's price cut in cell phone packages – and not a sign of heightening inflation pressures.
- The Fed's 2% inflation target is based on the Personal Consumption Expenditure (PCE) Index, which on average has run around 35 basis points below the CPI measure since 2009. Although the March reading of 1.9% was up from 1.6%, the recent run-up in prices appeared concentrated in a few volatile inputs.
Investors could consider taking advantage of the recent jump in yields to invest in US Treasuries, which, as well as yield, may also provide portfolio protection in case of market shocks. Speculative traders hold a near-record short position in US Treasuries, and may be forced to cover if inflation or economic data falls short of expectations. And even stagnating yields could be enough to trigger short-covering, since the carry on 10-year Treasuries makes it expensive to be short.
Barring a significant acceleration in core PCE inflation, we remain confident in our overweight position in 10-year Treasuries in our global tactical asset allocation.
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