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  1. Home
  2. / Investing
  3. / Fixed Income

As the Fed Spreads Its Wings and Circles, Keep Your Focus on Bonds

The Fed is more hawkish, but what does that mean for investors?
By BOB LANG
Jun 21, 2021 | 11:00 AM EDT

We often say the bond market tends to lead us into good or bad situations. After all, bond traders are so paranoid about losing money or buying power they could have predicted seven of the last two recessions (sarcasm). Yet, following the tracks of bond players tends to be a winning formula; it's the timing that is often a bit out of sync with the markets.
 
Flash to the Fed meeting last week, the statement and press conference that followed basically told us what they have been saying months about inflation being transitory, but with one slight change. The committee started talking about recent inflation trends and perhaps setting a stop on accommodative policy. We expected that discussion sooner or later, but we could have looked to the bond market for better clarity than even the Fed provided.
 
You see, if inflation were a real problem, the bond vigilantes would be out in droves selling bonds like there was no tomorrow. But that has not been happening, rather the opposite. Bond buying has been sharp and vigorous over the last month, with yields falling again. What happened to all the talk of the 10 year bond reaching 2% or more? The Fed has been seeking 2% or higher inflation for an extended period, perhaps 12 months or more.
 
That seems to be asking a lot, but certainly we see that strong trends in price action reflected in consumer price index and producer price index data. If that is that case, then what gives? Shouldn't we see a drop in bond prices rather than a pickup? That's the rub here, and the bond market seems to believe the Fed in that inflation trends are not blowing in the wind currently.
 
The yield curve is flattening more and more with the spread of 2/10 bond yields at its lowest level since February and still falling. Simply put, the bond market is reflecting little inflation in the economy and growth prospects are dimming for 2022 and beyond. Certainly not what the Fed has been looking for, so market conditions may stay the same for the foreseeable future.
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At the time of publication, Lang had no position in any security mentioned.

TAGS: Bonds | Federal Reserve | Fixed income | Interest Rates | Investing | Rates and Bonds | Stocks

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