A bad week for inflation sceptics

Inflation sceptics might not be impressed by this move; however, breakeven rates are not the only indicators proving that more inflation might rise. While the 2s10s part of the US yield curve is failing to steepen beyond 100bps, the amount of money supply (M1) in the economy is unprecedented, suggesting that spending should rise impacting inflation directly.

The $1.9 trillion Covid relief plan is also playing a big part in the reflation story.

Suppose one doesn't believe that the fiscal stimulus will be enough to stimulate inflation. Still, it should pose some questions around one's strategy over nominal US Treasury bonds.

Even if inflation does not go higher, nominal yields will rise anyway in light of higher government bonds' supply to finance fiscal spending. Yesterday, the US Treasury announced the issuance of 2-, 5- and 7-year notes for a total of $183bn next week. And it is just the beginning. US Treasury Secretary nominee Janet Yellen said before the Senate Finance Committee this week that she will look at the possibility to issue ultra-long government bonds. Even though this was something that her predecessors failed to do, it doesn't mean that there is no probability that it will happen in the future. It implies that Treasury bond issuance might become particularly heavy on the long-term side, and the yield curve will steepen further, inferring more pain on investors.

Once the spread between the 10- and 2- year Treasuries break above 100bps, it will most likely find resistance around 120bps. We already know by now that the front part of the US yield curve is not moving, thus only long term rates will suffer this loss. A 20bps movement in 10 year Treasuries corresponds to around 2% loss for bondholders, while on 30-year Treasuries it will be already about 5%.

The only solution? Seeking coupon income and inflation hedging.