In an opinion piece for Bloomberg, former NY Fed Chair Bill Dudley shared his thoughts on why there is likely to be more weakness in Treasuries despite increasing indications that inflation is bending lower. 

While longer-term yields have declined as a result, they are starting to creep higher as the economy continues to show momentum with some signs of an acceleration. Hopes that the Fed’s hiking cycle was over seem premature as Fed funds future markets now show hikes at the next two meetings.

Even if the Fed is close to the end, a robust economy means that rates will likely stay elevated at these levels for a prolonged period of time. Further, Dudley sees structurally large deficits, baby boomers spending down retirement accounts, and capital expenditures in renewables and reshoring supply chains as reasons that inflation is likely to linger above the Fed’s 2% target. 

Higher inflation will also erode returns on longer-term Treasuries, leading to higher yields. This has the potential to cause stress to the financial system as we saw with the regional banking crisis especially as Treasuries make up the capital base of so many institutions. However, Dudley sees one silver lining as it could force politicians to address the country’s weakening fiscal situation.

Finsum: Former NY Fed Chair Bill Dudley doesn’t share the market’s optimism that the worst of the inflation surge is over. He sees structurally higher inflation as a headwind for Treasuries.