I noticed something interesting last week and must admit that this is not something I follow like a hawk on a daily basis.
What I noticed was that US Treasury Inflation-Protected Securities (TIPS) or Inflation-Index bonds, have not been doing very well lately. I especially noted this in the 5yr TIPS market where yields are almost back to pre-election levels. Weird, shouldn't they be going higher if inflation (expectations) is likely??
The way these bonds work are that when inflation or inflation expectations rise, the value of these bonds rise because they track and protect against inflation by being "linked" to inflation itself.
By now, we are all mostly aware of what the new Administration is trying to do...IE...reflate the US economy. With that, stocks rose and bonds, especially longer-dated bonds (30 years) fell. Remember, inflation (expectations) is the enemy of government bonds, especially long bonds. And that did happen through Nov and Dec.
But lately, since mid December's high yields, US bonds have not been able to make new highs. That is Observation #1. Maybe it is because as I wrote last week here: highrockcapital.ca/pauls-blog/the-usand-the-fed that US Treasury Bonds are a "crowded trade" with everyone in the world looking for higher rates being driven by Trump's reflation and the Fed wanting to raise rates.
And then, as I started this post saying, I noticed that something didn't add up in the TIPS market. 5 year TIPS are almost back to pre-election levels. Observation #2. If inflation is really going to be a problem from here, shouldn't TIPS bonds be on fire? The fact they aren't is a bullish sign for government bonds.
And add to that, the correlation between the S&P 500 and 10yr US Treasuries has moved back to it's more normal inverse correlation (means that if stocks get hit, bonds should rise in price) (Second Chart). Observation #3
So here is the 5 year TIPS chart:
And here is the S&P 500 vs 10yr Treasury Bond correlation chart. Remember, the higher (green shaded area and where the white arrow is on the right) it gets, the more we expect bonds to move in the opposite direction of stocks (which adds a natural hedge to our portfolio):
So, by looking at the TIPS market, we can draw some conclusions about inflation (expectations), government bonds/yields and even stocks.
At High Rock, we talk about "Research" but it is what we do with this research that really matters. Because of our 3 Observations, we put the research to work and re-purchased some of our 10yr Government of Canada bonds that we sold in September 2016. Actionable Research.
And remember, bonds lead all other asset classes so what we see going on in the bond market can affect other asset classes.