Surge in Rates May Be Overstating the Case for Inflation

U.S. rates have moved substantially higher in the past few weeks, advancing a trend that’s seen Treasury yields rise from historic lows amid the depths of the pandemic last year. As markets try to gauge whether economic growth and inflation could accelerate more quickly than anticipated in 2021, many investors are left wondering whether rates will climb further in the near term. We think upward pressure on inflation is likely to be relatively contained as the global economy continues to recover from the effects of COVID-19, and that yields on longer-dated bonds should stay broadly bounded within recent ranges as central banks keep short-term policy rates anchored near zero.

While there were several catalysts for the bond market sell-off that began in February, which saw 10-year Treasury yields reach the highest levels in about a year, concerns about inflation expectations played a large role. The U.S. yield curve steepened as longer-dated rates rose more than short-dated ones, typically signaling higher expectations for economic expansion and inflation down the road. Although such periodic sharp rate increases can be painful in the short term for bond portfolios, the opportunity for yields to reset higher can offer attractive entry points for active fund managers like PIMCO, and ultimately provide higher income and return potential for investors. Passive funds that track a benchmark may be locked into certain investments even as rates rise, giving active managers with broader, more flexible mandates room to outperform.

The magnitude of fiscal stimulus and accommodative monetary policy in response to the pandemic has positioned 2021 to be a recovery year, alongside vaccine rollouts that should help the U.S. and the world rebound from the negative effects of COVID-19 on economic activity and employment. We are cautiously optimistic on the pace of that recovery (see this January 2021 blog post). We remain alert to the potential implications for price growth, yet we don’t see a substantial risk of a rapid acceleration in inflation, particularly in the near term. There are still several potent forces in place that could curb wage gains and keep inflation in check, even as the Federal Reserve and other central banks maintain low rates and bond-buying programs, and as the U.S. government expands fiscal stimulus spending.