During a cold winter with plenty of snow, a sunny day with temperatures in the upper 30s can feel like spring relief. It still is cold — especially for those of us in south Florida — but the relative warmth can change one’s mood.
Much the same can be said of the bond market and inflation. Interest rates remain historically low, but the cost of borrowing is getting more expensive compared to just a few months ago over worries about future inflation.
Look no further than the cost to borrow money to buy a home. The average interest rate on a 30-year fixed-rate mortgage popped above 3% last week — a six month high. Three percent for money today that one pays back over the next three decades is cheap by historic measures, but the mortgage market is simply a reflection of an increasingly nervous bond market.
Inflation is the enemy of bond investors. It eats away at the worth of future interest payments. Bond investors look for security in knowing they will get their investment back, along with something extra in the form of the interest payment. Inflation rates remain low by historical standards — under 2%. However, expectations of future inflation have been growing.
Worries that inflation will erode the value of bond interest payments has been creeping into the bond market this year, pushing down bond prices and pulling up market interest rates.
The Federal Reserve has been clear in communicating that it will remain patient with inflation should it flare up. It has pledged to keep its target interest rate low for a couple of years. However, market anxieties can run well ahead of any calming reassurances from the central bank. More people receiving their COVID-19 vaccinations, more stimulus spending by the federal government, and improving consumer confidence have helped feed inflation concerns.
Investors will examine February consumer and wholesale inflation data when they are released on Wednesday and Thursday in the week ahead, looking for signs of sustained higher prices.
Nervousness in the bond market rattles the confidence of stock investors. No investor wants to get caught out in the cold.
