• Inflation proves to be stubborn
• End of the hiking cycle excellent opportunity to add long-duration bonds

Inflation

The Personal Consumption Expenditures Price Index (PCE), a critical inflation gauge for the Federal Reserve, increased by 2.5%^[1] year-over-year in February. The Core PCE inflation rate, which excludes the more fluctuating prices of food and energy, went up by 2.8%, aligning with analysts’ forecasts.

From one month to the next, PCE experienced a 0.3% rise from the preceding month, which was below the anticipated 0.4% growth. This monthly growth rate marks a slight deceleration from January’s 0.4% month-to-month increase. Similarly, Core PCE witnessed a 0.3% monthly increase.

Despite a reduction in inflation rates compared to the previous year, the latest report did not fuel optimism for an interest rate cut by the U.S. central bank in its upcoming May meeting. The market continues to predict a nearly 96%^[2] probability that the Fed will likely maintain the current interest rate at the next policy meeting.

In recent months, the annual growth rate of the money supply has turned negative, a phenomenon last observed during the Great Depression.

Additionally, it’s generally understood that changes in the money supply precede shifts in inflation by an average of 16 months.

Therefore, even though inflation has demonstrated a tendency to be somewhat sticky in the near term, it is expected to decline further.

As inflation approaches the target rate of 2%, the Federal Reserve will start to lower interest rates.

Bonds

It is widely recognized that bonds with longer durations respond more to interest rate fluctuations than their short-term counterparts.

This phenomenon occurs due to the inverse relationship between bond prices and interest rates. As interest rates decline, the value of bonds with longer maturities typically increases more than that of bonds with shorter maturities.

This is due to the longer timeframe during which the fixed-rate payments are made, which enhances their value in periods of declining interest rates.

Mean-Reversion

The prevailing market outlook indicates that the cycle of reducing interest rates will likely commence around the middle of the year.

TLT (Long 20y+ Bonds) experienced an unprecedented nearly 50% decline since the early pandemic days.

However, the bond ETF partially recovered from its lowest point of just above $81 in October of 2023, a drop of nearly -2SD (standard deviations) below its mean.

Source: Yahoo Finance

As markets anticipate three to four interest rate reductions this year, this outlook is notably positive for long-term assets, such as the TLT (20+ Year Treasury Bond).

It is projected that the TLT will gradually return to its mean level of around $113.

Also, notice the incredible volume spike lately, which implies that many investors might be piling into the bond ETF due to the imminent rate reductions.

Inventors can long the TLT using our 5x 20+ Year Treasury Bond.

Alternatively, traders can short the TLT using our -5x 20+ Year Treasury Bond.

1. Fred
2. Cmegroup