4.25%. The total return for the Bloomberg Barclays Aggregate Bond Index has enjoyed a positive total return during five of those periods. In the two periods when the total return was negative, the bond index lost a total of 2.89% during 1987 and 2.04% during 1994. With the 10-year Treasury yield at about 1.5%, the bond market is clearly not concerned about long-term inflation. However, as the economy continues to recover, and with short-term rates rising, the longer-term yields are likely to rise as well. A good indicator of this relationship is the interest rate spread between the 2-year and 10-year Treasury yield. This spread has been a very accurate indicator of pending recessions when the shorter-term yield is higher than the long-term rate, that is, when the yield curve is inverted. When the economy is expanding and inflation pressures are high, the spread between the 2-year Treasury and the 10-year Treasury has risen to as high as 2.5%. With the current 2-year Treasury yield at around 0.50%, the current spread is about 1%.
Inflation–More Than Transitory Written and prepared by: Robert Janson, CIMA®, AIF® Senior Vice President, Senior Portfolio Manager, Wealth Services
inflation, currently around 3.2% annualized, tends to exhibit longer staying power. Sticky categories include rent , owners’ equivalent rent, insurance costs and medical expenses. Flexible prices are those that change Sticky [price] categories include rent, owners’ equivalent rent, insurance costs and medical expenses. price relatively frequently, including food and energy. The relationship between steadier sticky prices and more volatile flexible prices also mirrors the relationship between the CPI and the Producer Price Index (PPI), with the CPI generally much less volatile than the PPI. Covid-related raw material production, manufacturing slowdowns and supply chain
disruptions during the early portion of the recovery caused the PPI and flexible prices to escalate when the rapidly rising consumer demand completely outpaced the ability for the supply chain to meet the demand. Increasing consumer demand was aided by the rapid improvement in the employment picture. At the height of the Covid shutdown, the initial claims for unemployment insurance surged to ten times the typical recession levels. After only 18 months, this leading indicator is down to the levels only seen during the best parts of a growing economy. The relationship between employment and inflation is described by the Phillips Curve. The Phillips Curve argues that unemployment and inflation are inversely related: as levels of unemployment decrease, inflation increases.
Now that the economy has recovered from the 2020 Covid-19 shutdown, the dominate investment concern is inflation. The stock and bond markets are wrestling with the challenge of whether the current higher inflation is “transitory,” as the Federal Reserve has stated, or is going to be longer lasting. Investors are looking for opportunities to provide “real” return on their money to overcome the impact of rising prices. Define Inflation THE ATLANTA FEDERAL RESERVE has defined two parts of the Consumer Price Indexes (CPI) as “sticky” inflationand“flexible” inflation. According to them, if the price changes for a particular CPI component occur less than every 4.3 months, that component is a “sticky-price” good. Goods that change prices more frequently are “flexible-price” goods. Sticky
Investments During Periods of Higher Inflation Bonds THE FIXED RETURN that most bonds provide means they are very sensitive to the impact of inflation on their real total return. However, history has shown that bonds reflect negative total returns only during periods when inflation was greater than 6%. Since 1983, the Fed has increased the Fed Funds rates during seven different periods. During those periods, the Fed increase the rate by minimum of 1.75% to maximum of
The Federal Reserve had a significant impact on the rapid recovery of the market through the aggressive interest rate policy as well as the stimulus provided to the financial markets. To combat rising inflation, the Fed has already begun to “taper” the stimulus and is likely to start raising the Fed Funds rate during 2022. For now, the Fed is projecting only one increase next year, while the futures market foresees at least two increases. Short-term rates are likely to end 2022 between 0.50% and 1.00%.
Personal Finance Quarterly | Winter 2022
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