The bond market is wrong about inflation

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invest2bfree
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The bond market is wrong about inflation

Post by invest2bfree »

Updated article by Scott Grannis, I have been following Scott for sometime-

Wednesday, January 12, 2022
Scott Grannis

"The bond market is wrong about inflation

I've been making this point for quite some time now, so the purpose of this post is mainly to update the argument with the latest news. I would also like to recommend an article by Thomas Sargent and William Silber that appeared in today's WSJ: "The Market Is Too Serene About Inflation." They make essentially the same points I do, but they nicely add some historical context. In the 1980s, it took the bond market a long time to realize that the Fed had successfully brought inflation down from double- to single-digits. What we're seeing today is similar, only opposite: it's going to take the bond market a long time to realize that the Fed has allowed inflation to increase significantly.

And by the way, I was an avid student of inflation and the bond market back in those crazy days of the early- to mid-1980s. I worked for John Rutledge at his consulting firm (the Claremont Economics Institute) during that time, and we were almost alone in our conviction that the combination of Volcker's monetary policy and Reagan's tax cuts would result in a huge decline in inflation and interest rates. It took a few years, but we were finally proven right. So I'm not totally surprised to see the bond market making another mistake, even if the circumstances are quite different this time around.

Chart #1 compares the yield on 10-yr Treasuries to the year over year change in the Consumer Price Index. We've never seen such a huge difference between the two, and I for one never thought something like this would or could ever happen.

As Chart #2 shows, oil prices have nothing to do with today's inflation problem. Ex-energy inflation is off the charts. And to judge by the huge difference between today's inflation and today's interest rates, the bond market has only just begun to be concerned.

Chart #3 shows the ex-post real yield on 10-yr Treasuries (i.e., the difference between nominal yields and the rate of inflation according to the CPI). Real yields today are lower than at any time in my lifetime. The last time we saw anything like this was in the inflationary 1970s.

As Chart #4 shows, there is about an 18-month lag between rising rents (about 25% of the CPI is based on what homeowners think they would be paying to rent the house they own) and rising inflation. Given that rents are up only a little less than 4% in the past year, while housing prices nationwide are up about 20%, there is likely a lot of rent inflation that has yet to find its way into the CPI over the next year. "



http://scottgrannis.blogspot.com/2022/0 ... ation.html
Last edited by invest2bfree on Sun Jan 16, 2022 11:00 am, edited 2 times in total.
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furiouschads
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Re: The bond market is wrong about inflation

Post by furiouschads »

Never fight the bond market.
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vtsnowdin
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Re: The bond market is wrong about inflation

Post by vtsnowdin »

As Chart #2 shows, oil prices have nothing to do with today's inflation problem. Ex-energy inflation is off the charts. And to judge by the huge difference between today's inflation and today's interest rates, the bond market has only just begun to be concerned.
If he believes that there is no reason to read on.
Even the inflation of the 70-80s was brought on mostly by OPEC becoming the dominate oil producer replacing the USA.
RedDog
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Re: The bond market is wrong about inflation

Post by RedDog »

CletusCaddy wrote: Sun Jan 16, 2022 10:57 am
MishkaWorries wrote: Sun Jan 16, 2022 10:52 am
furiouschads wrote: Sun Jan 16, 2022 10:47 am Never fight the bond market.
There is no bond market when the Feds are in there buying hand over first to artificially suppress interest rates. We'll see what the bond market says after the government stops manipulating it.
The market includes all actors, including the government, and has always included those actors. To speak of some mythical bond market which only includes those influences you prefer to consider pure is not only nonsensical, it’s worthless for investment planning.
It’s not nonsense if the Fed is making a substantial portion of the purchases. Even more so if the purchases are for monetary policy purposes versus investing.
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invest2bfree
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Re: The bond market is wrong about inflation

Post by invest2bfree »

vtsnowdin wrote: Sun Jan 16, 2022 11:09 am
As Chart #2 shows, oil prices have nothing to do with today's inflation problem. Ex-energy inflation is off the charts. And to judge by the huge difference between today's inflation and today's interest rates, the bond market has only just begun to be concerned.
If he believes that there is no reason to read on.
Even the inflation of the 70-80s was brought on mostly by OPEC becoming the dominate oil producer replacing the USA.
He is talking about the 2022 inflation not the 70s.
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vtsnowdin
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Re: The bond market is wrong about inflation

Post by vtsnowdin »

invest2bfree wrote: Sun Jan 16, 2022 11:19 am
vtsnowdin wrote: Sun Jan 16, 2022 11:09 am
As Chart #2 shows, oil prices have nothing to do with today's inflation problem. Ex-energy inflation is off the charts. And to judge by the huge difference between today's inflation and today's interest rates, the bond market has only just begun to be concerned.
If he believes that there is no reason to read on.
Even the inflation of the 70-80s was brought on mostly by OPEC becoming the dominate oil producer replacing the USA.
He is talking about the 2022 inflation not the 70s.
He discussed both saying he had 80s experience. That a fifty percent rise in energy prices will not work through the entire system causing double digit inflation is just illogical and totally against precedent.
Perhaps his chart does not show it yet but it will if any of his data are correct.
CletusCaddy
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Re: The bond market is wrong about inflation

Post by CletusCaddy »

RedDog wrote: Sun Jan 16, 2022 11:15 am
CletusCaddy wrote: Sun Jan 16, 2022 10:57 am
MishkaWorries wrote: Sun Jan 16, 2022 10:52 am
furiouschads wrote: Sun Jan 16, 2022 10:47 am Never fight the bond market.
There is no bond market when the Feds are in there buying hand over first to artificially suppress interest rates. We'll see what the bond market says after the government stops manipulating it.
The market includes all actors, including the government, and has always included those actors. To speak of some mythical bond market which only includes those influences you prefer to consider pure is not only nonsensical, it’s worthless for investment planning.
It’s not nonsense if the Fed is making a substantial portion of the purchases. Even more so if the purchases are for monetary policy purposes versus investing.
Yes the Fed has been doing things. The Fed always does things. That’s what they do. They may change course, but but guess what, they can always change back (how many rounds of QE are we on by now?) They are always there, in the background, doing things or considering to do things.

To say that the market will inevitably get back to a “natural state” without the Fed’s influence is by definition nonsensical because there is no market without the Fed.

Here is an analogy. My evening commute is only 15 minutes without any traffic, any construction, and any accidents. But there is always traffic, construction, and accidents. So does it ever make sense for me to say that my commute is only 15 minutes?
Angst
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Re: The bond market is wrong about inflation

Post by Angst »

invest2bfree wrote: Sun Jan 16, 2022 10:40 am "... and we were almost alone in our conviction that the combination of Volcker's monetary policy and Reagan's tax cuts would result in a huge decline in inflation and interest rates. It took a few years, but we were finally proven right."
Once in the past, Scott Grannis braved a tide of negative opinion regarding inflation and turned out to be right, so maybe he is again! :)

invest2bfree wrote: Sun Jan 16, 2022 10:40 am Chart #1 compares the yield on 10-yr Treasuries to the year over year change in the Consumer Price Index. We've never seen such a huge difference between the two, and I for one never thought something like this would or could ever happen.
"We've never seen" is technically correct, but so is "We've essentially seen", back in the mid-1970's.

invest2bfree wrote: Sun Jan 16, 2022 10:40 am As Chart #2 shows, oil prices have nothing to do with today's inflation problem. Ex-energy inflation is off the charts. And to judge by the huge difference between today's inflation and today's interest rates, the bond market has only just begun to be concerned.
So? Energy isn't the primary driver this time around. Other things are.

invest2bfree wrote: Sun Jan 16, 2022 10:40 am Chart #3 shows the ex-post real yield on 10-yr Treasuries (i.e., the difference between nominal yields and the rate of inflation according to the CPI). Real yields today are lower than at any time in my lifetime. The last time we saw anything like this was in the inflationary 1970s.
And...?

invest2bfree wrote: Sun Jan 16, 2022 10:40 am As Chart #4 shows, there is about an 18-month lag between rising rents (about 25% of the CPI is based on what homeowners think they would be paying to rent the house they own) and rising inflation. Given that rents are up only a little less than 4% in the past year, while housing prices nationwide are up about 20%, there is likely a lot of rent inflation that has yet to find its way into the CPI over the next year.
This is the only thing I find interesting, but it's just interesting, not the conclusion to an argument.

Scott Grannis may prove to be right again, but I'm not convinced, either way. I'm inclined to think this inflationary spike is manageable and will be adequately managed, in time, but I'm not sure. I'm satisfied that the members of the Fed open market committee are not deluding themselves.
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SimpleGift
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Re: The bond market is wrong about inflation

Post by SimpleGift »

invest2bfree wrote: Sun Jan 16, 2022 10:40 am The bond market is wrong about inflation...
To believe that the bond market today is wrong about future inflation, one has to believe that all of the factors that have led to falling inflation and interest rates over the last three decades are somehow going to magically reverse, once the dislocations caused by the pandemic work their way through the global economy.
  • - Are birth rates in the developed world somehow going to start rising?
    - Are populations going to stop aging in most major economies around the world?
    - Is the globalization of labor going to completely reverse in the years ahead?
    - Are the technological advances that have been driving down inflation going to cease?
Methinks the bond market, while not perfect, is much smarter than many folks give it credit for.
RedDog
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Re: The bond market is wrong about inflation

Post by RedDog »

CletusCaddy wrote: Sun Jan 16, 2022 11:29 am
RedDog wrote: Sun Jan 16, 2022 11:15 am
CletusCaddy wrote: Sun Jan 16, 2022 10:57 am
MishkaWorries wrote: Sun Jan 16, 2022 10:52 am
furiouschads wrote: Sun Jan 16, 2022 10:47 am Never fight the bond market.
There is no bond market when the Feds are in there buying hand over first to artificially suppress interest rates. We'll see what the bond market says after the government stops manipulating it.
The market includes all actors, including the government, and has always included those actors. To speak of some mythical bond market which only includes those influences you prefer to consider pure is not only nonsensical, it’s worthless for investment planning.
It’s not nonsense if the Fed is making a substantial portion of the purchases. Even more so if the purchases are for monetary policy purposes versus investing.
Yes the Fed has been doing things. The Fed always does things. That’s what they do. They may change course, but but guess what, they can always change back (how many rounds of QE are we on by now?) They are always there, in the background, doing things or considering to do things.

To say that the market will inevitably get back to a “natural state” without the Fed’s influence is by definition nonsensical because there is no market without the Fed.

Here is an analogy. My evening commute is only 15 minutes without any traffic, any construction, and any accidents. But there is always traffic, construction, and accidents. So does it ever make sense for me to say that my commute is only 15 minutes?
“To speak of some mythical bond market which only includes those influences you prefer to consider pure is nonsense…”

You’re speaking to a mythical bond market that excludes your preferred influences.
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Re: The bond market is wrong about inflation

Post by dbr »

Whether right or wrong in either direction, I think it is much too early to be so sure what is going on.

The kinds of shocks we are living through now are not unprecedented as to being shocks but the nature of them is unprecedented and so is projecting the outcome.

Is it really surprising that bonds have not whipsawed in response to less than or about a year of actual inflation? But then I don't know anything really.
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Taylor Larimore
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Re: The bond market is wrong about inflation ?

Post by Taylor Larimore »

Bogleheads:

The total bond market, like the total stock market, reflects the combined opinion of millions of investors (most stock and bond transactions are by highly trained professionals). We can disagree with these experts, but when we do, we are more likely to be wrong than right.

Best wishes
Taylor
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Re: The bond market is wrong about inflation

Post by Kenkat »

Anytime you see the words “wrong” and “the market” in the same sentence, proceed with caution.
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Re: The bond market is wrong about inflation

Post by drk »

gougou wrote: Sun Jan 16, 2022 11:55 am They will do that if they have to. The bond market doesn’t may not reflect the risk of high inflation because there’s a Fed distorting the market, making bonds a bad investment in terms of risk/reward.
I would weaken the statement because we don't actually know the extent of the distortion.
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Re: The bond market is wrong about inflation

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I removed an interchange regarding government manipulation of the market. This thread has run its course and is locked (not actionable, economic policy, conspiracy theory). See: Non-actionable (Trolling) Topics
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