Fund Flows Into Bonds Suggest Eventual Unwind of Bearish 10-Year Treasury Trade

investing.com:

While bond yields have risen sharply lately, fund flows into bonds tell two very different stories. We have previously written much on the recent rise in bond yields related to economic growth, event risks, and recessions. To wit:

“Since rates and expectations must adjust for the potential future impact on the current value of invested capital:

Therefore, the long-term correlation between rates, inflation, and economic growth is unsurprising.“

“That chart is pretty cluttered, so the following chart is a composite index of inflation and economic growth compared to the 10-year Treasury yield.”

Of course, that analysis contradicts the views of Ray Dalio, Bill Ackman, Bill Gross, and others who currently expect rates to go higher. The disconnect comes down to time frames. More importantly, investors must understand the difference between short-term market-driven narratives and the long-term economic dynamics that drive interest rates.

Such is the basis for our discussion in this blog.

Over the last two years, interest rates on Treasury bonds have risen in response to two primary factors. On the short end of the Treasury curve, the 1-month to 2-year Treasury bonds are heavily influenced by the Federal Reserve’s monetary policy changes. As shown, there is an exceedingly high correlation between the Fed funds rate and the 2-year Treasury.

However, the long-end of the yield curve, 10-year Treasury bonds or longer, are driven almost entirely by expectations for economic growth, inflation, and wages, as shown above. Notably, the correlation is very high.

“As expected, the surge in economic growth and inflation pulled longer-duration yields higher. With a correlation of nearly 85% between interest rates and a GDP/Inflation