Inflation has peaked – or at least that is what the bond market may be saying.
Government bonds on Wednesday took Canada’s soaring inflation figure for June in stride, bolstering the argument by many analysts that the fast pace of consumer price increases this year may have hit its highest level last month.
The yield on the 10-year Government of Canada bond rose less than six basis points, to about 3.14 per cent, following the release of inflation figures. The yield on the two-year bond rose less than one basis point. There are 100 basis points in a percentage point.
The slight increase in the yields looked relatively muted next to an annualized inflation reading of 8.1 per cent in June, up from 7.7 per cent in May and the highest reading since 1983.
“Even though current inflation is very high, there are some who think that we may have peaked, and that the way forward is for inflation to come down,” said Vinayak Seshasayee, portfolio manager at Pacific Investment Management Co. (Pimco).
Inflation has soared globally after a period of ultralow interest rates and supply chain challenges pushed up prices for gasoline, food, commodities and just about everything else.
In Britain, inflation climbed to 9.4 per cent in June. And in the United States it touched a new four-decade high of 9.1 per cent last month, underscoring the Federal Reserve’s urgency in raising its key interest rate.
Bond yields, which move inversely to prices, are sensitive to inflation and have been moving upward this year. Bond prices have been hammered, delivering some of the worst returns in decades for bond investors.
Yet yields on some government bonds were higher earlier this year and have subsided substantially from those earlier peaks.
The yield on the 10-year Government of Canada bond rose above 3.66 per cent in mid-June. Since then, it has declined about 50 basis points, or half a percentage point. Though up substantially since the start of the year, the yield is now back to where it was in early May.
Similarly, the yield on the 10-year U.S. Treasury bond is just above 3 per cent now, down from a recent high of about 3.5 per cent on June 14 – about a month before investors saw June’s high inflation reading.
The market appears to be suggesting that central banks will be successful in taming inflation with aggressive interest rate hikes. Last week, the Bank of Canada raised its key rate by a full percentage point. And officials with the U.S. Federal Reserve are signalling a 0.75-percentage-point increase next week.
As well, fast-falling prices for gasoline and other commodities such as copper and lumber suggest one major cause of inflation is now subsiding.
Risks of recession are also brewing, which could be weighing on bond yields. Though unemployment remains low, demand for U.S. manufactured goods and services is declining, and gross domestic product declined 1.6 per cent at an annualized rate in the first quarter of the year.
“If it turns out that we are imminently going into recession, that greatly increases the odds that 10-year bond yields peaked last month,” said David Stonehouse, head of North American and specialty investments at AGF Investments Inc..
Still, Mr. Stonehouse added that the way forward for bonds is not entirely clear.
A recession might not occur, and better-than-expected economic activity could push bond yields up again. Also, even if inflation has peaked, it might stall at a relatively high level or fail to subside fast enough for central banks to ease up on rate hikes.
“If inflation doesn’t come off the boil quickly, it may be premature to anticipate that bond yields have peaked,” Mr. Stonehouse said.
What’s more, observers noted that the bond market’s reaction to Canada’s latest inflation reading could have been caught up in other events, such as moves in the U.S. bond market and even rising political uncertainty in Italy.
“We wouldn’t read too much into any one day’s price action, because it is typically driven not only by local news but also by global factors,” Pimco’s Mr. Seshasayee said.
Even if bond yields are reflecting the view that inflation has peaked, he added, the market could remain volatile.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.