Soaring oil, bond yields enter the inflation group chat

·Editor focused on markets and the economy

Wed, Sep 29, 2021, 2:55 AM3 min read

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Wednesday, September 29, 2021

Suddenly, soaring oil and sagging bond prices are complicating DC’s messy tasks

On Tuesday, two major trends converged, and managed to kill two birds with one stone. Commodity bulls and bond vigilantes joined hands to shake up a market that's become too complacent with the status quo, and sent a pointed message to Washington’s perpetually quarreling establishment.

Ahead of D.C.’s deadline to avert a federal government shutdown and a self-inflicted debt ceiling calamity, a sell-off in bonds quickened, triggering a rout in stocks and a spike in interest rates.

Heating up the toxic brew is the price of oil (CL=F), which looks like it is prepping a run above $80 per barrel, especially with global demand so high. Energy shortages in China and the U.K. underscore how fuel price spikes are starting to hit home for industrialized countries.

The moves in markets couldn’t possibly have come at a worse time, with the Federal Reserve carefully calibrating the market’s anxieties about both soaring prices and curtailing its massive bond purchases by next year.

And some think the former is increasingly likely to impact the latter — which is partly why bond investors seem to be forcing the government’s hand.

“Inflation expectations are finally catching up to inflation and the drama in Washington,” Gene Goldman, CIO at Cetera Investment Management, told Yahoo Finance on Tuesday, who argued that the Fed “has been severely underestimating the stickiness of inflation.”

With regard to soaring prices, “transitory” has become a byword of pandemic-era central bank policymaking. The Fed anticipates that much of the pressures pushing up inflation will eventually dissipate.

However, Goldman argued that “the eventual landing spot [of inflation] will be above the pre-pandemic and Fed target levels.” As of August, headline prices were running above 5%, with core prices not far behind.

“If inflation was as transitory as the Fed suggests, year-over-year inflation should not be this high,” Goldman told Yahoo Finance in an email.

“With tapering being the first step to remove stimulus and the Fed not wanting to expand its balance sheet while raising rates, the Fed is most likely to begin tapering ASAP (November) so that if inflation keeps rising, they can address it with higher rates faster,” the investor added.

Within the last week alone, the benchmark 10-year Treasury has added around 20 basis points, while the inflation-sensitive two-year yield spiked to its highest in over a year, according to Marc Chandler, chief market strategist at ??Bannockburn Global Forex.

Interest rates have sharply risen during the last two weeks. (Goldman Sachs)

And given that yields are still too low relative to U.S. economic growth, Cetera’s Goldman thinks the 10-year could breach the psychologically important 2%.

As if containing the dragon of inflation wasn’t enough work, the specter of a government shutdown — or worse still, a default — makes the outlook that much worse. Treasury Secretary Janet Yellen has warned Congress that the debt limit must be raised or suspended by Oct. 18.

While almost nobody expects Uncle Sam will stop paying his bills, Washington’s highly partisan atmosphere is enough to give investors a serious gut check, especially because technology and growth-sensitive stocks are sensitive to rising rates.

"Below the surface of the equity market, long-duration growth stocks have started to underperform as rates have risen, consistent with the historical pattern," Goldman Sachs analysts wrote on Tuesday. "Rising interest rates pose a greater risk to the valuations of long-duration stocks given the high share of cash flows expected to be generated in the distant future."

By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek