Is The ‘Bond Rout’ Real? Should We Panic Over Inflation?

• “No doubt the rise in bond yields is a healthy response to good pandemic news… But is this healthy?” – The WSJ Editorial Board

The biggest economic story this year was of course the impact of the pandemic. How well did the media do in reporting this story? Here’s a disturbing answer.

The Negativity Skew, Verified

Researchers from Dartmouth and Brown University studied 9.4 million news articles about the Covid pandemic published in English language global mainstream media sources during 2020. U.S. media coverage of the pandemic was overwhelmingly negative in tone and content. 

• “U.S. major outlets publish unusually negative COVID-19 stories… Relative to other media sources, the most influential U.S. news sources are outliers in terms of the negative tone of their coronavirus stories and their choices of stories to cover.”

It didn’t matter whether Covid infections were rising or falling, or whether the articles were triggered by vaccine successes. “The steady drumbeat of good news about the vaccines has been met with a chorus of relentless pessimism.” 

American coverage was the worst. U.S media was much more negative than non-U.S media. 

The most prominent outlets – the New York Times, CNN, NBC – were the most extreme in streams of negativity. 

  The Times itself has now discovered the problem, and has called for “self-reflection.”

• “The news about the vaccines continues to be excellent — and the public discussion of it continues to be more negative than the facts warrant.” 

The “Bond Rout” & Inflation Panic

But our main concern is with the financial market… and in that sphere, the big news – at least at the macro-economic level – is the recent tremor in the bond market. 

Yes, bond yields have moved up a little. Which means bond prices have fallen. Apply the negativity skew. Headline writers like the word “rout.”

• “Bond markets left smarting from worst rout in years as reflation goes global” – Reuters 
• “Bond Rout Hits Safest Company Debt” – WSJ
• “Financials may be a silver lining in bond market rout” – Financial Times
• “Goldman Warns That Global Rout in Bonds Has Room to Run” – Bloomberg
• “Bank of England Aligns With the Fed Over Rout in Bond Market” – Bloomberg

Big Things, and maybe Bad Things, are happening:

• “Something big just happened in world markets [Bloomberg says]… Remarkable events… great drama…… decent evidence that bond yields have reached a high enough level to thwart further advances in the stock market… at what point bond yields become too high for stocks to bear, and cause them to fall. I hope you survive Friday…” 

The “rout” threatens, well, almost everything, from the stock market (your 401-K, dear reader) to the housing market (higher mortgage rates!). It’s a “tantrum.” “Volatility is back.” “Inflation obsession.” Lions and tigers and bears.

The Wall Street Journal Loses It Over 50 Basis Points

In the sudden storm, The Wall Street Journal editorial board lost its normal establishmentarian composure. That is to say, even the finance world’s most sober, self-appointed grown-ups went wobbly. Why? Because… the “most important price in the world economy” has gone haywire!

• “The yield on the 10-year Treasury note—the most important price in the global economy—surged to 1.37% Monday [Feb 22] from 0.917% at the start of the year. The German 10-year bund, the eurozone’s benchmark bond, on Monday hit an eight-month high of minus-0.28%, after rising 12 basis points last week. Japan’s 10-year government bond reached a two-year high of 0.12%. No doubt this is in part a healthy response to good pandemic news.…”

But what is the real significance? 

Inflation – it is just around the corner. In fact… 

Inflation already is here … (??)

How do we know? Well, the Journal marshaled the following evidence:

• “Bitcoin is up about 80% this year!”

Bitcoin? Seriously? That is what the WSJ editors have sagely settled on as the first item to support their inflation thesis? But the terrors multiply.

• “Copper has nearly doubled in price since March…” 
• “…emerging-market bonds have been issued in higher-than-normal quantities… “
• “…soaring asset prices…the S&P 500 and Nasdaq set new records …”
• “…and Brent crude oil is back to about $65 a barrel.”

And don’t forget those German bond yields. They’ve moved up a little also. From Ludicrously Low to merely Ridiculously Low.

Still negative. But less negatively negative. Which must be bad, since in the bond yield business a positive move is more negative than a negative move, apparently. Anyway, it is enough to invoke the negativity skew.

The Questions to Ask

1. Is this negativity at all warranted? Is the “rout” really a rout? 
2. Does the negativity skew in the coverage come with a cost? That is, does it become its own problem, or should we just ignore it and turn to the sports pages?  

This column will address the first question. The second will be the focus of a follow-on piece.

Does Pessimism Equal Reality? 

So, is the negativity here justified? Do the trends cited really signal danger?

The answer is No. These “danger signals” don’t bear scrutiny.  

Copper

Take copper. The normal reading of the copper price is that it reflects a strong uptick in manufacturing, and a positive economic trend. 

• “Copper has long been considered a leading indicator of global economic health. More than any other base metal, copper is tied closely to manufacturing, electrical engineering, industrial production, information technology, construction, and the medical sector. In general, rising copper prices have indicated strong demand and global economic strength; lower prices, a weaker economy.”

In fact, the price of copper has a negative 38% raw correlation with the Consumer Price Index (ex Food & Energy). That is, it is not a reliable signal of inflation.

So, yes, the price of copper is rising, but the price of copper rises sharply in an economic recovery. It is in fact a signature of the recovery. That is what is happening here. 

Crude Oil

Take crude. The rise in the price of oil – which, be it noted, only brings it back to where it was in Jan 2020 – reflects a recovery of demand and an improving economic outlook. This is well understood. E.g., Reuters’ headline: “Oil prices rise on expected economic recovery.”

• “The biggest driver for the latest surge in prices seen through last week was a sharp upturn in expectations for economic and oil demand recovery on signs that the coronavirus may finally be in retreat.”- BBC 

Stock Markets etc.

And should we really worry that emerging markets are able to raise capital now on better terms? Or that the stock market is setting records? 

Those are questions that answer themselves. No graphics required. 

The “Bond Rout”

And what of those “surging” bond yields, which prompted the WSJ piece? 

Well, you can make the data sing many different songs. Here is how the WSJ charted Treasury yields in its February article. Like a rocket, right? 

Here is a bit of context. (Since it is the media coverage in focus here, this is a snapshot from the date of the WSJ editorial). 

Treasurys are below the Jan 2020 level. The recent rather gentle rise looks more like… well, a recovery.

Here is more context. It wasn’t that long ago that 10-year Treasurys were yielding 2%, 2.5%, 3% or more. And of course the economy and the stock market boomed through it all (before the pandemic hit). Yields are still well below the long-term trend line. 

The Significance of the “Bond Rout”

And why are bond yields rising? 

Because investors are selling them. Selling pushes the price down, as with any asset, and since the interest is fixed (these are “fixed income” instruments after all), the yield must rise. 

And why are investors selling Treasurys? 

Well, this is where the fault line runs. There are two answers on offer:

• inflation fear
• recovery cheer 

The Inflation Thesis tells us that when inflation returns it will crush the bond market, so investors are bailing out before the disaster. 

The Recovery Thesis holds that – as another recent WSJ article headlined – “U.S. Treasury Yields Log Biggest Weekly Gains in Over a Month: Investors bet the economy will gain strength in the coming months.” (The WSJ is not 100% coherent in its stand on this matter.)

The Recovery Thesis is clearly the correct interpretation. The rise in bond yields is a signal of strong economic growth developing in the next few quarters. The Fed has forecast something like 5-6% GDP growth this year. Investors are positioning themselves to benefit from the expected gains in the equities market, and so, unsurprisingly, they are withdrawing funds that had been in safe-haven assets like Treasurys to redeploy to higher yielding asset classes. 

This reasoning is also based on the fact that the Inflation Thesis has a fundamental problem…

There is no inflation. (!!)

Excluding volatile food and energy costs, inflation is trending near its lowest level ever.

Over the last decade, the 12-month moving average has never been lower. 

The recent trend is particularly striking. The inflation rate has dropped by half in the last year – and it has stayed low as the economy has begin to recover. Would it constitute a crisis if inflation were to return to the 2018-2019 levels?  

Well, who ya gonna believe, me or your own eyes?

So why in the world are so many people convinced there is an inflation problem? The numbers clearly show there is none. At least not yet.  

The negativity skew is in full force. The commentariat has overwhelmingly run with the sky-is-falling story. 

• “Many think more pain is coming. The chorus of bond bears, never short of a baritone or tenor over the past decade, has swelled dramatically this year, as a procession of big-name money managers have started singing from the same sheet.” 

The “bond rout” has been drilled into our heads. The experts have mostly succumbed. Inflation is “the new bogeyman” — more feared now than the pandemic itself. In the Bank of America’s latest regular monthly survey of professional fund managers, 37% now list inflation as the number one risk facing the market. 35% fear a “bond tantrum.” Only about 13% are still worried about Covid, which had been the leading risk factor in the previous 11 monthly BofA surveys since April 2020.

Leading luminaries — the people we think we should listen to – are sounding the alarm. 

Citadel’s Ken Griffin

• “‘There is a possibility we see a real surge in inflation,’ Griffin said. ‘The question is whether it is transitory or becomes permanent and structural, and there is a much higher chance that it becomes entrenched than any other time over the past 12 years.’ He warned of a ‘doomsday’ scenario win which accelerating inflation deepens a bond market sell-off, sends stocks tumbling and stokes unrest among retail investors hurt in the process.” 

Bill Gross, the Bond King

• “Inflation, currently below 2%, is not going to be below 2% in the next few months,” Gross said. “I see a 3% to 4% number ahead of us.”

Ray Dalio, Bridgewater chief

• “The economics of investing in bonds (and most financial assets) has become stupid. Think about it. You have to take into consideration inflation. In the US you have to wait over 500 years, and you will never get your buying power back in Europe or Japan. In fact, if you buy bonds in these countries now you will be guaranteed to have a lot less buying power in the future.” 

Michael Burry, Mr. “Big Short” 

• “The investor compared Germany’s path to hyperinflation in the 1920s to America’s current trajectory. ‘Germany [the US] started by not paying adequately for its war [on COVID and the GFC fallout] out of the sacrifices of its people – taxes – but covered its deficits with war loans [Treasuries] and issues of new paper Reichsmarks [dollars].’ #doomedtorepeat, Burry tweeted.”

Ed Yardeni

• “Investors [should] question guidance that inflation is temporary and due to year-over-year pandemic comparisons. Ed Yardeni, president of Yardeni Research, says the 27% increase in the monetary supply could help create an inflationary boom in the second half of the year. To Yardeni, summer is the point at which it will become clear that building inflation isn’t so temporary. Year-over-year readings of 2.5% or higher after June will mean that price increases are indeed a problem, he says, an outcome he anticipates.”

Warren Buffett

• “Inflation is now more of a threat than it has been in the past few decades. Warren Buffett has laid out the risks of inflation for investors in Berkshire Hathaway: ‘Inflation is a gigantic corporate tapeworm,’ the CEO of Berkshire told shareholders. It ‘preemptively consumes its requisite daily diet of investment dollars regardless of the health of the host organism. Under present conditions, a business earning 8% or 10% on equity has no leftovers for expansion, debt reduction or “real” dividends. The tapeworm of inflation simply cleans the plate.’”

(Gotta say — Warren has a way with words.) 

The Toxicity of Negativity

Had enough? 

How can such relentless and quasi-universal negativity not influence our thinking about the nature of this “problem”? How should we interpret all these frantic alarms? Are we in the smoke-must-mean-fire scenario, and, despite the statistics showing actual inflation is nowhere to be seen, heed these warnings? Or – is all this just the sound of the media selling its products in the time-tested fashion – “if it bleeds, it leads”?

Or – maybe it is our own fault, as consumers? We apparently, perversely, prefer negativity. The media are just giving us what we want. An academic study, entitled “Consumer Demand for Cynical and Negative News,” designed an experiment to test consumer preferences for tone and content of news stories. They found that

• “Participants often chose stories with a negative tone – corruption, set-backs, hypocrisy and so on – rather than neutral or positive stories. People who were more interested in current affairs and politics were particularly likely to choose the bad news. And yet when asked, these people said they preferred good news. On average, they said that the media was too focussed on negative stories.”

Whether this skew is a supply-side phenomenon (systematic media bias) or a demand-side one (consumer preference for bad news), or a mix of the two, it is a fact. It affects financial reporting systematically, and distorts our understanding of topics like the modest bounces in bond yields over the past couple months. 

It seems quite clear — at least so far — that the move in bond metrics is a positive sign, a response to what is expected now to be a very strong economic recovery. But the dominant media narrative has been gloom and doom – a position that the numbers do not support. This extraneous negativity has polluted our thinking.

The important next question is: Does it matter? We might conclude that it’s just the usual media chatter after all – and does not alter “reality” very much. The recovery will come on despite the squawking. 

Or is there a cost of this toxic surge of negativity? Does it influence, and skew, and even corrupt the decisions of investors, economists, central bankers? If we are utterly convinced (wrongly) that inflation is now the biggest problem we face, that perhaps (absurdly) even runaway inflation could be at hand… What policy mistakes may this lead to? That will be the subject of the next column.