© Richard B. Levine/Zuma Press MARKET EXTRA
If there were any doubts before, the sharp rise in U.S. bond-market inflation expectations has forced investors to confront the the specter of higher consumer prices.
"The reflationary sentiment is well intact and evidence of persistently higher inflation expectations is no longer an open issue," said Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets.
The combination of further fiscal relief from Congress, a decline in COVID-19 cases, and the accelerating rollout of vaccines are creating a powerful cocktail of forces that are expected to unleash at least a temporary rise in consumer prices in 2021 on investors as the economy recovers further.
Investors have piled into Treasury inflation-protected securities in a bid to avoid the corrosive impact of intensifying price pressures on portfolios.
The 5-year breakeven inflation rate, or what holders of TIPs anticipate consumer prices to average over the next 5 years, soared to 2.30% on Thursday, a more than seven year high.
Long-term Treasury prices have also taken a hit in the past week as bonds with extended maturities are vulnerable to inflation fears as they can erode the value of their fixed-interest payments.
The 30-year Treasury bond yield was nearing the key 2% level on Friday, and was trading at 1.95%.
Trading in other corners of financial markets show it's not just bonds that are jumping on the reflation bandwagon with the economy seen recovering further from the coronavirus pandemic this year. The S&P 500 and Nasdaq Composite set a new record on Thursday, while the Dow was flirting with its own all-time high, too.
Read: U.S. Treasury market reloads bets on reflation
In theory, higher inflation could rattle Wall Street if it sends longer-term interest rates up and the U.S. dollar to levels where stock-market investors get uncomfortable.
Yet, investors say the rise in longer term yields is likely to be capped as the Federal Reserve has a clear commitment to its new average inflation targeting regime which allows temporary overshoots of inflation above 2%.
As a result, the timetable for Fed interest rate hikes and a tapering of asset purchases may not necessarily come forward even as the economy gets back on its feet.
"The Fed will continue to back the market," said Nick Maroutsos, head of global bonds at Janus Henderson Investors, in an interview.
Even as stocks, bond and commodities all point to the widespread of acceptance of the reflation narrative, that story hasn't converted everyone.
Many remain skeptical of the notion that the U.S. economy will see a more lasting return to a higher inflationary environment, if only because the structural factors that have hurt consumer demand and kept interest rates low, such as an aging population, have not gone away.
"It remains to be seen if slightly higher inflation data is anything more than transitory," said Matt Forester, chief investment officer at BNY Mellon's Lockwood Advisors, in e-mailed comments.