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Illustration: Eniola Odetunde/Axios

Investors are picking sides in a battle happening in the bond market that is seeing inflation expectations surge higher but nominal U.S. Treasury yields remain low and anchored in a tight range.

Why it matters: The disconnect between inflation expectations and the Treasury market could be driving much of the risk-taking behavior in assets like stocks, cryptocurrencies and commodities.

Break it down: Real yields — the yield on U.S. government bonds minus inflation — fell to an 11-week low this week and are headed back toward their all-time low close.

  • The lower real yields fall the more investors are inclined to move further out on the risk scale in a search for yield, so they can generate positive returns for their clients.

What's happening: While more money has plowed into stocks this year than over the last 12 years combined, investors also are buying record amounts of inflation-protected bonds (10 times the quarterly average of the past 20 years in Q1).

  • "Real yields are at all-time lows, so it’s really sort of a question of here and now the market pricing in all of these supply pressures," Subadra Rajappa, head of U.S. rates strategy at Société Générale, tells Axios.
  • "I’m just not sure the market has fully bought into this narrative from the Fed that rising inflation will actually be transitory."

The big picture: Inflation has become the biggest worry among market participants and a growing discussion topic among American families who are seeing prices rise across the board. But expectations for continued price increases are no longer being reflected in the all-important Treasury market.

  • Normally, investors sell bonds as inflation measures rise because it erodes the value of already-held bonds, but perhaps because of guidance from the Fed and chair Jerome Powell the opposite has happened.

By the numbers: The 5-year breakeven rate (a measure of investors' inflation expectations over 5 years) rose to 2.66%, its highest since a spike in July 2008 and about 30 points from the highest levels ever recorded in the data series.

  • 10-year breakeven rates are at their highest levels in more than 8 years and 30-year breakevens are at the highest since September 2014, according to Fed data.
  • But since the end of March, yields on the benchmark 10-year Treasury note have fallen by 18 basis points to 1.57%.

The bottom line: "There’s a tug of war within the market as to not just whether or not current price increases are transitory," says Quincy Krosby, chief market strategist for Prudential Financial. "But even if it is, how long does it last?"

Charted: Inflation expectations versus Treasuries
Expand chart
Data: FRED; Chart: Dion Rabouin/Axios Visuals

Kathy Jones, chief fixed income strategist at Schwab, says she's not expecting double-digit inflation spikes as the U.S. saw in the 1970s, however, "I do think we could land at a higher level of inflation than we’ve had in the past," she tells Axios.

  • "Instead of limping along at 1.5% as we've done over the past decade, we could land at 2.5% or land at 3%."

Why it matters: That may not seem like much, but it would mean the current rate of price hikes continues and would represent the highest inflation the country has seen in at least 25 years.

Go deeper

Biden White House jammed on gas prices

Illustration: Sarah Grillo/Axios

The Biden White House increasingly views rising gasoline prices as a source of potential political peril — and is now asking some of the world's biggest oil producers to pump more oil.

Why it matters: This trend, combined with a fragile economic recovery threatened by the Delta variant of the coronavirus, and inflation beginning to bite consumers, could threaten the administration's ambitious congressional agenda for late summer and early fall.

1 dead, 14 injured in shooting at Kroger grocery store near Memphis

One person was killed and 14 others were injured Thursday in a shooting at a Kroger grocery store in Collierville, Tenn., near Memphis, the town's spokesperson Jennifer Casey said, per CNN.

What they're saying: "I've been involved in [police work] for 34 years and I have never seen anything like [this]," Police Chief Dale Lane said at a press conference.

3 hours ago - Health

CDC panel recommends Pfizer boosters for high-risk individuals, people 65 and up

Photo: Marco Bello/Anadolu Agency via Getty Images

A key panel at the Centers for Disease Control and Prevention on Thursday recommended the Pfizer-BioNTech coronavirus booster shots for people 65 years old and older, as well as those at high risk of severe COVID-19.

Why it matters: The approval is the near-final step in making the booster shots available to tens of millions of Americans, and comes a day after the FDA approved Pfizer boosters for the two groups. CDC director Rochelle Walensky is expected to announce her recommendation soon.