As the COVID-related economic weakness that characterized the first half of the year subsides, growth has begun to return as trillions in fiscal stimulus have helped to stabilize consumer spending. Against a backdrop of improving labor market conditions and retail sales, inflation expectations have been on the rise after plummeting in March.
As shown in the LPL Chart of the Day, breakeven inflation, measured by the yield difference between Treasury Inflation-Protected Securities (TIPS) and their nominal counterpart, has been on a wild ride in 2020, and have now returned to levels last seen in February:
In order to fund the historic stimulus measures, the US Treasury has issued record amounts of long-maturity bonds to pay the bill. Taking note of normalizing inflationary pressures following the surprise July Consumer Price Index (CPI) beat, investors demanded additional compensation for growing inflation expectations during the Treasury auction, pushing Treasury yields higher and presenting a potential headwind for future returns.
“Despite record issuance, the yield on the 10-year Treasury is still only trading around 70 basis points (0.70%),” noted LPL Chief Market Strategist Ryan Detrick. “Given such a low coupon, Treasuries will be even more sensitive to fluctuations in interest rates, which presents a challenge to investors looking for high quality options in the fixed income market,” he added. We continue to favor TIPS relative to nominal Treasuries, as rising inflation may pressure bond yields toward our year-end target of 1.0-1.5%.
The uptick in inflation expectations is unlikely to have an impact on the path of future monetary policy, as recent comments from Federal Reserve (Fed) officials have shown a willingness to let inflation run a bit higher than their previous target of 2%. With inflation expectations rising, this may limit the urgency of the Fed to implement additional interest-rate tools to spur growth, but the Fed will likely delay raising interest rates until there is strong clarity that the economy is on a firm footing, which could take a while.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
All index and market data from FactSet and Bloomberg.
This Research material was prepared by LPL Financial, LLC.
Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).
Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.
- Not Insured by FDIC/NCUA or Any Other Government Agency
- Not Bank/Credit Union Guaranteed
- Not Bank/Credit Union Deposits or Obligations
- May Lose Value
For Public Use – Tracking 1-05045591
