The Great Transitory Debate. Breaking Down The Latest Inflation Numbers.
Through the first half of 2021, fixed-income investors have been faced with their greatest fear: inflation. This evolving phenomenon has led to higher interest rates, sparking volatility in fixed-income markets. 2021 has seen U.S. Treasuries off to one of their worst starts in years as the Bloomberg Barclays U.S. Treasury Index was down 4.25% through Q1 (the first quarter), with the Long Bond portion down a whopping 13.51%. This type of volatility has left most bondholders scratching their heads and wondering how their portfolio could fare in an inflationary environment. Investors and economists likely would agree that a steady increase in prices over time is normal and healthy for a consumer-based economy, but too much of it in a short timeframe could cause serious volatility. The main fear is that in order to counter inflation and keep it from running too hot, the Federal Reserve would have to raise the federal funds rate, which could ultimately put pressure on financial markets.
Bonds typically underperform when interest rates trend higher and we have seen this come to fruition this year. As the economy recovers from the pandemic-induced shutdown, a little inflation was certainly expected; however, recently passed fiscal stimulus, record-setting deficits, unprecedented accommodative monetary policy and supply chain disruptions are all adding up into a nice stiff inflation cocktail that’s stronger than what the market expected. Despite seeing some of the highest inflation upticks in over 10 years, the Federal Reserve holds the position that these changes will be temporary.