U.S. inflation set to rise this year, but bond traders shouldn’t buy the hype, says Goldman

Consumer inflation climbs 0.4% in December on higher gas prices, CPI finds

Don’t buy into the hype around inflation.

Goldman warns investors are set to face a temporary rise in inflationary pressures later in the second quarter of 2021, but advised bond traders to look past its resurgence and snap up U.S. Treasurys even if others sold government debt in panic.

If the upswing in inflation pushed yields higher, “we would likely be inclined to fade the repricing given the transitory, backward-looking nature of the impulse,” said William Marshall, an interest-rate strategist at Goldman Sachs, in a Wednesday note.

Inflation is one of the main bugaboos of bond investors as it can corrode the returns of fixed-income assets, but also bring forward the timing of rate hikes.

See: BlackRock’s CEO says a leading investor is flagging worries about valuations and inflation

Fears that U.S. price pressures will heat up come amid expectations the Biden administration’s openness to additional fiscal aid could bolster the U.S. economic recovery, potentially pressuring the Federal Reserve to push away from easy monetary policy sooner than they had signaled.

But Marshall argued much of the inflationary surge set to take place this year would be due to so-called base effects, when weaker months of inflation were phased out from yearly measures as time passed, leading to mechanically higher price levels.

This phenomenon would take effect during the next few months when the deflationary hit from the coronavirus pandemic last year is removed from the annual inflation measures reported by the U.S. Labor Department, he said.

Growth in core personal consumption expenditures, the inflation gauge preferred by the Federal Reserve, stood at 1.4% in November.

Though base effects are often predicted well in advance, Marshall noted their fleeting impact nonetheless could bolster bond investors’ long-term inflation expectations.

If such fears, in turn, trickled into higher yields on government bonds, he said it would make sense to buy Treasurys on the dip, as the Federal Reserve was likely to look past such base effects.

The 10-year Treasury note yield

was up 1.7 basis point to 1.107% on Thursday.

In other markets, the S&P 500
Dow Jones Industrial Average

and Nasdaq Composite

were on pace to ring in another round of records, after closing at all-time highs on Wednesday.

Read: All theories of what generates higher inflation are pointing in the same direction – up: Fed’s Bullard

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