Cautious central banks and decelerating economies take the attention away from inflation.

Supply will continue to weigh on the long part of the yield curve for the next six months unless the direction of monetary policy changes. As long as bond futures are pricing the terminal rate to remain around 4%, 10-year yields will need to price accordingly. Historically, 10-year yields offer a pickup between 100 – 150 basis points over the Fed Fund rate. With rates expected to drop to 3.75% in the next ten years, it would be fair to expect 10-year yields to trade between 4.75%- and 5.25%.

The Bank of England is not credible.

The Bank of England is losing its credibility. Not only is the country suffering from the highest inflation among developed economies, but the labor market will remain tight due to COVID-19. The central banks' economic projections are meaningless and are going through an overall review by Ben Bernanke. Within this context, Bailey is mimicking peers.

With the 3-month SONIA rate showing that rates are not dropping below 4%  in the foreseeable future, we can expect long-term Gilts to remain under pressure. It's still very likely that 10-year yields will break above 4.5% as inflation in the United Kingdom becomes entrenched.

The Bank of Japan’s path to normalization underpins higher long-term yields globally.

We must remember that although the Fed, the ECB, and the BOE might be done with interest rate hikes, the BOJ is just joining the party. At this week's monetary policy meeting, the BOJ updated its economic projections, showing expectations for inflation to remain at 2.8% for this fiscal year and the next (therefore, until April 2025) and to drop below 2% only in 2025, revising inflation figures upward every single year. That means the BOJ forecasts inflation to be more persistent than estimated, warranting a normalization of monetary policies. Despite keeping its Policy Balance Rate at -0.10% and its target to 10-year Japanese Government Bond (JGB) yields at 0.00%, the central bank allowed for greater flexibility in bond yields, saying the 1.00% upper bound "hard cap" would become a "reference." Although minor, this step is a sign that policy normalization is in sight and that we are going toward higher JGB yields. Higher JGB yields mean that real money would buy securities at home rather than locking a negative return in USD and EUR sovereigns one hedged against the Japanese Yen. This would put pressure on long-term sovereign bonds on both sides of the Atlantic.

What does that mean for investors?

It means that duration is expensive while the front part of the yield curve has peaked. As I have outlined in this article, the front part of the yield curve allows investors to take minimal duration risk, while maximizing return. Unless yields on 2-year notes rise more than 500bps, investors holding this securities for a year would always be in the green.

The 10-year tenor also brings an attractive risk-reward ratio; however, the longer the duration, the more directional is one's bet. Let's remember that those investors entering long-dated securities at the beginning of the year are now stuck until their position recovers. In order to extend duration considerably, it's critical to see inflation reverting to central banks' target or changing their hawkish posture.