Chart Of The Day - Treasuries Troubles

Inflation aftershocks and thinking the unthinkable...

Return-Free Risk: For an asset typically thought of as risk-free, an inflation adjusted drawdown of -50% would seem impossible, but there it is for all to see in the chart below. Of course, if you hold treasuries to maturity, the nominal return is virtually risk free in terms of credit risk (although Fitch may disagree on that) — but when you put the bond in a fund you have to deal with mark-to-market capital losses (or gains) as interest rates go up and down.

• The latest leg down in treasuries has been triggered by a mix of BOJ changing its bond yield caps, commodity prices rebounding (think inflation), and concerns around the prospect of the Fed going “higher for longer”.

• Although the rate of inflation has clearly peaked (thanks to base effects, backlog normalization, bear market in commodities), the level of CPI has not fallen, so the hurdle for real (inflation-adjusted) returns remains high.

• In terms of next steps, on my indicators treasuries look attractive (valuation, sentiment, cycle), and many of the indicators that flagged caution for bonds in 2020/21 have flipped in the opposite direction. But at the same time inflation and policy indicators caution that yields could go a wee bit higher yet.

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Callum Thomas
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