BFI Group Blog

Stay informed about the news at BFI and in a world of rapid change

BFI Bullion
March 15, 2019

Bond Yield Reaction to Powell - Is Inflation on the Horizon?

On February 27th, Fed Chairman Powell, in the typical Fed cryptic talk, left us once again with more questions than answers. Nonetheless, the market reacted, and it appears it concluded that inflation could be on the horizon. And that’s something we should all take note of.

Fed Chairman Powell hinted that the Fed would “not drain the balance sheet too much”. In other words, we can expect that the Fed’s balance sheet will never get back to its pre-2009 levels. As far as the “draining” (or tapering) goes, it will certainly not be radical by any means – the US$ 25 billion reduction per month is not happening. Powell has recognized the danger of depriving the market of liquidity too fast, as the economy and financial markets are still highly addicted and dependent on the Fed’s “accommodative” policies.

The reaction by financial markets was instant. Stock markets liked Powell’s speech as could be expected. They rose briefly, while gold retracted. However, the most interesting – and somewhat contradictory – reaction could be seen in long-term bond yields: from February 27th to March 4th, they rose by over 1.5%.

ProShares Short 20+ Year Treasury, as of March 11th

Source: Yahoo! Finance

We should not ignore this signal! Even though, over the past few days, the S&P has been sliding, while gold has been rising again and long-term bond yields have retracted, I have taken note of the yield move we witnessed after Powell’s speech. It can be seen as an early signal that, contrary to general expectations, financial markets are starting to expect inflation on the horizon.

Of course, everyone expects interest rates to remain low for a long time and there’s much that supports that scenario. Yet, the bond yield reaction was interesting. And, as our readers know, official inflation numbers are generally to be taken with a pinch of salt. For more accurate figures, we’d rather refer to John Williams’ website, “Shadow Stats”. His inflation numbers, as depicted in the following chart, highlight the fact that inflation is not as low as officially communicated.

US Consumer Inflation – Official vs. ShadowStats (1980-Based) Alternate

Data as of February 13th, 2019


We think we are starting to see inflation expectations on the rise. We can see companies reporting rising prices for materials, employee salaries moving up and skilled workers are in high demand, as the official jobless rates are at historic lows. At the same time, the Fed, the “mother of monetary inflation”, has just told us that its “tapering drive” won’t fly quite as high as announced at the end of last year.

Powell is not Volcker. He won’t fight inflation. But even the Fed cannot control long-term rates. Are we seeing the end of the bond bull market, the end of lower rates? We think so. Keep your eye on yields. As they move up, in sync with higher inflation expectations, stock markets will start to falter, bonds will correct, and the Fed, together with its other central bank buddies, will once again inflate and support financial markets. Only this time, with the effectiveness of central bank measures waning, it will be much harder to achieve their goals.

This is certainly the time to protect your wealth by diversifying out of mainstream paper assets. A proactive, defensive strategy geared towards alternatives is highly recommended.

Download PDF Blog Post
Download • 288KB