No signal from the bond market can be taken in isolation, and the recent decline in long-term Treasury yields is no exception—but what, exactly, is the meaning of falling long Treasury yields when they are accompanied (seemingly counterintuitively) by an economy that is heating up, rising inflation, strong equity prices and yields on high-yield bonds at all-time lows?
Theories to explain these mixed market signals include the idea that the economic recovery has peaked…that the worsening pandemic will be even worse than many expect…that there is an excess of liquidity (hence the Treasury buying)…and that the Federal Reserve’s control over long-term rates (through its aggressive bond buying) is so strong now that traditional market forces’ effect on bond prices has waned.
Dan Zwirn, CEO of Arena Investors, believes that the Fed and other monetary authorities have artificially propped fixed-income prices to the point that investors (in investment grade and high-yield in particular) perceive essentially no risk, thinking the authorities “will move heaven and earth to protect them from panics and whatever items cause them.” Zwirn’s further point: This is a false lesson. Inflation could be a real and lasting factor—and if it is, authorities will not be able to nor want to protect markets to this extent indefinitely.
At some point, Zwirn says, the dangers of ongoing fiscal overspending will become apparent enough that the Fed’s message will likely change from “inflation is transitory” to “we have inflation.” If that happens, Zwirn concludes, “we will see how difficult it is to get that genie back in the bottle.”