What happens to Treasury yields and market when inflation walks in?

For as long as markets have functioned broadly, participants have attempted to place a quantitative framework around and over them to better understand, describe and hopefully exploit their machinations. And while it does provide some context, ultimately, they’re still driven by behavioral incentive that might best be described as non-linear and reflexive across shorter time frames that more or less eventually conform with general equilibrium theory.

As we alluded to in our note last month, it was a good bet that the inflation data was due to turn up again, as US dollar strength had run its course in May. We’ve pointed out over the years that the YOY performance of the dollar has led the inflation data and we’ve closely followed the rollover in real yields.

Although the equity markets here in the US have continued to defy gravity, we suspect similar to the completion of the cyclical bull market of the mid 1940’s, their fate will be sealed when realized inflation surprises to the upside and greater uncertainty prevails with future Fed policy.

Consequently, we continue to like the long-term prospects for gold, as it has displayed a strong inverse correlation with real yields and should also benefit from the prospective safe-haven demand generated by the eventual cyclical decline in equities.

Source: Bloomberg Pro Terminal

Trader Bozhidar Arabadzhiev

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