Inflation: “How does anyone know it will be transitory?”

Inflation might be a problem at some point in the future. Seemingly, just not yet.

The striking uptrend in inflation gained further impetus last month, with US core prices, excluding food and energy, rising by 3.8 per cent over the past 12 months to May, the fastest rate in nearly 30 years.

Yet in the same week US Treasury yields were flat, having peaked back in March. Likewise, equities are more than holding their own, as well as their nerves.

One explanation is increasing price-agnostic demand for US Treasuries at banks. They have to hold huge amounts of very liquid, ‘safe’ assets. US bonds fit the bill. German Bunds don’t necessarily. This demand is led by the Federal Reserve which is buying - every month - $80 billion worth of Treasuries.

The other explanation for flat yields is that ‘markets’ - in their infinite wisdom - are viewing the current inflation spike as transient, or transitory. A case of ‘this too shall pass’.

“How does anyone know it will be transitory?” - this was how one leading bond investor put it this week.

Indeed. No one does. It’s just another ‘known unknown’ that investors of all stripes and colours have to deal with. What we do know is that entrenched, persistent inflation will not be good for bonds, and could be problematic for equities. These are difficult times for asset allocators and indeed all investors.