Renewed COVID-related lockdowns in Europe are providing a tailwind for U.S. bonds as equities are trading down in the news. Further supporting lower bond yields is poor consumer sentiment and a weak Labor Participation Rate. With 70% of the U.S. economy driven by consumption, there is a growing feeling that the economy may have peaked. With winter approaching and COVID cases rising in Europe and in parts of the U.S., the Fed may not need to raise short-term rates as we previously believed. It is important to remember that the markets are dynamic and that the pandemic can quickly change sentiment, economic output, and overall confidence by consumers and business owners.
The counterargument for higher yields is that the COVID-related supply disruptions and behavioral changes have created rampant inflation with too much demand chasing limited goods. Fiscal and monetary stimulus are just exacerbating the issue as more money floods into the system, costs of goods and devices will keep going up. Inflation is a problem for many working-class Americans as food, gas, and shelter costs have risen. Next week the Fed’s favorite reading on inflation, core PCE, will be released and closely read by bond traders and economists.
It would be wise to take advantage of this dip in interest rates. With inflation running well above 4%, locking in a rate lower than inflation is a great example of positive leverage while locking in a real negative rate.