U. S. Treasury prices have fallen again recently, while yields on 10- and 30-year Treasuries have risen. On March 3, the yield on the 10-year Treasury note, which is considered a market benchmark, rose as much as 9.5 basis points to 1.49%; the 30-year Treasury yield rose as much as 8.3 basis points to about 2.27%. The 10-year Treasury yield has been continued to rise significantly over the past year. One of the main factors driving Treasury yields higher is the market's fear of a return of inflation. Due to the current ballooning asset bubble, the market expects that the Federal Reserve may adopt a tightening policy in the future when inflation rises. For this reason, the market has started to adjust ahead of schedule.
Figure: U.S. 10-year Treasury yields since 2020
Is inflation on the horizon in the near future? The different judgments on this issue are not merely a theoretical debate on macroeconomics, but a practical issue concerning how countries should choose their macro-policies in the next step under the COVID-19 pandemic.
The global economy is at a rather unique moment right now, so to speak. In the wake of the COVID-19 crisis in 2020, countries have introduced unprecedented policy stimulus, with major central banks lowering interest rates to near 0% or even negative rates, and countries have introduced major fiscal policies to rescue their economies and guarantee employment and basic survival of their citizens. The asset prices have rebounded in the face of the massive easing by countries around the world. In the case of the U.S. stock market, the three major stock indexes have reached record highs amid negative global and U.S. economic growth. With unprecedented stimulus and asset bubbles, it is hard to keep markets from worrying about future inflation risks.
From the views of academics and market participants, there are obvious differences in inflation expectations. To the knowledge of ANBOUND researchers, markets and the academia have rarely had such disagreements on the macroeconomic phenomenon of inflation.
The current market expectations for inflation can be simply placed into two groups. The first group believes that inflation will appear soon; the second group, on the contrary, believes that there will be no significant inflation at present and in the future, or that the probability of inflation is small.
Lawrence Summers, the former U.S. Treasury Secretary, is among those concerned about the risks of inflation, arguing that Joe Biden's economic stimulus plan is ambitious but could set off "inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability". He argued that the USD 1.9 trillion stimulus package was three times the U.S. economy's expected output gap against a backdrop of the falling unemployment rate, exceptionally loose monetary conditions and potentially further strengthening of consumer demand. If the economy overheats and prices rise, the Fed could be forced to raise interest rates to curb inflation. Robert Barro, an economics professor at Harvard University, not only pointed out that inflation risks will emerge, but also criticized the policymakers of monetary policy and fiscal policy, arguing that the Fed's policies have destroyed the "legacy of Paul Volcker", i.e., reducing inflation with tight monetary policy. Barro said that current Fed Chair Jerome Powell should stress the dangers of high inflation; as for Treasury Secretary Janet Yellen, she should not overlook the excesses of public debt. The long-term expected inflation rate has risen sharply from 1% per annum in March-May 2020 to 2.2% in February 2021.
According to the research team of CICC, there are certain risks of inflation exceeding expectations in the U.S. this year. These risks mainly come from several aspects: On the demand side, if Biden's USD 1.9 trillion stimulus package is implemented, it will support household income and consumption, which will push up inflation. On the supply side, slower recovery in production than demand will also bring inflationary pressures. Li Zhan, chief economist of Zhongshan Securities, believes that overseas central banks are happy to see rising inflation. The continuous easing policy has not been supported by the fundamentals, but has stimulated the U.S. stock market to reach new highs and the U.S. dollar to depreciate, which has laid the hidden worries of inflation and asset bubbles. The current structure of the capital market shows that the price of commodities such as crude oil has risen, and the empirical relationship with the U.S. dollar and gold has been partially distorted.
There are also plenty of people who believe that there will be no significant inflation now or in the near future. For example, U.S. Treasury Secretary Janet Yellen pointed out that the inflation rate in the U.S. has been very low for more than a decade, and the greater risk to the U.S. will be an economic downturn compared to the risk of inflation. Yellen added that there are 15 million Americans behind on their rent payments, 24 million adults and 12 million children without food, and that a number of small businesses have closed. The USD 1.9 trillion stimulus package could help the U.S. return to full employment within a year, and without adequate policy support, the U.S. labor market could not recover until 2025. Yellen is not worried about government spending leading to inflation; she believes that the U.S. has tools to deal with the risk of inflation. Fed Chair Jerome Powell said the U.S. economy still needs monetary policy support and that the current economic recovery remains "uneven and far from complete." Powell said the Fed would remain focused on getting Americans back to work during a vaccine-driven recovery. He added that the monetary policy needs to remain accommodative and the Fed will "act carefully and patiently". Fed Governor Lael Brainard stated the uptick in U.S. inflation was a temporary phenomenon, the Fed will take no action on this, but instead it will maintain its accommodative policy. CEOs of Wall Street giants including Goldman Sachs and BlackRock have all pointed out that the government should immediately enact a massive federal stimulus package to deal with the impact of the pandemic and that the economy needs a strong stimulus.
Among Chinese professionals, Chan Kung, founder of ANBOUND, has been clear that he does not believe inflation is imminent. While the stimulus to date has unleashed a lot of liquidity, it will eventually be absorbed by the capital markets, education and cultural consumption, and technology investment. In addition, there are various kinds of infrastructure projects that countries are planning, including a lot of ecological investment projects, which will also require a large amount of capital investment. In fact, there's not much that really involves consumer goods. In the era of overproduction, excess capital often takes the form of excess inventory. Taken together, the likelihood of inflation is low.
There is also a neutral view of a simultaneous rise in Treasury yields and inflation. What does it mean if that happens? Vishwanath Tirupattur, credit strategist at Morgan Stanley, stated that understanding the reasons for the rise in yields is a key issue and it requires decomposing nominal yields into inflation expectations and real yields. He added that of the roughly 55bp pick-up in 10-year yields since the beginning of 2021, only about 20bp is from higher inflation expectations and 35bp is from higher real yields. As inflation expectations fall, real yields will rise.
Final analysis conclusion:
Overall, the rise in 10-year Treasury yields is a sign of strengthening inflation expectations in the U.S. market. However, despite the fact that the global economy has been steeped in credit expansion and excess capital since 2008, inflation has not risen significantly. In this context, inflation judgments based on conventional economic theory may need to be revised in light of changing circumstances. Significant inflation is unlikely in either the U.S. or in China.
