Bond Market Shows Inflation Is Transitory, Citi’s Bailin Says

(Bloomberg) -- Federal Reserve Chairman Jerome Powell may have moved away from calling inflation transitory, but not Citigroup Inc.’s David Bailin. He says the bond market is showing that inflation won’t be persistent and that negative real rates of return will remain.

“The bond market is really telling everyone a strong message but people don’t want to believe it,” Bailin, chief investment officer at Citi Global Wealth, said in an interview on Bloomberg TV’s Surveillance on Friday. “When you take a look at spreads out on the curve, you’re going to see a message that inflation will not be persistent, that it ultimately will normalize.”

Bailin spoke just hours before the U.S. Labor Department reported that last month’s consumer price index increased 6.8% from November 2020, in line with forecasts and extending a trend of sizable increases that began earlier this year. Yet the yield on 10-year Treasuries fell to 1.47%, while stocks gained.

The Citi strategist says the 10-year yield will rise in 2022, but not enough to offset inflation. The key is for the rising prices associated with the pandemic’s disruption of the global economy to not become core to inflation, said Bailin. 

“If you take a look at every single recovery, it has been about a total of 150 basis points between the bottom and the top,” Bailin said. “If that turns out to be the case, we could see the 10-year between 2% and 2.1% next year. The economy could handle that. Right now, all of the nature of the inflation is associated with very unusual parts of the market where we believe it’s transitory.”

In fact, investors need to position themselves to be ready for inflation running at about 2.5% for the next decade, Bailin said. 

“We’re telling our clients right now that they do have to worry about the fact they could get negative real rates of return for a very long time,” he said. “Certainly the short end of the corporate bond market could do poorly.”

In stocks, he recommends high-quality, high-dividend companies. “If you put together a great dividend portfolio with good earnings prospects, you may do very, very well over the next five years,” Bailin said.

He also sees value in alternative investments. “Lower rates for longer are going to be extremely good for alternative investments,” Bailin said. “You want to be a borrower in the environment. The ways of doing that are getting exposure to private equity, to late stage venture capital, to certain types of real estate that are benefiting from the digital change.” 

©2021 Bloomberg L.P.