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The U.S. economy is heating up. So is inflation. That’s kneecapping long-term bonds.

At yesterday’s testimony before the House Financial Services Committee, Fed head Janet Yellen said that the U.S. economy was "very close to achieving" objectives of maximizing employment and maintaining a stable inflation rate of 2% (the Fed's inflation target). On the news, investors anticipated the Fed would raise rates faster than was originally expected. The 2-Treasury yield jumped (from 1.206% the day prior to as high as 1.25%).  

Investors don’t yet appreciate that the Fed is falling behind on growth and inflation. Interest rates could rise much faster than is expected. Data released yesterday confirmed this line of thinking:

  1. Retail Sales – The year-over-year growth rate in retail sales hit 5.6% yesterday, a level not seen since March 2012.
  2. Consumer Price Inflation (CPI) – Core inflation just hit the highest level in 5 years. CPI accelerated to +2.5% year-over-year in January versus +2.1% in December. Inflation has now accelerated for the 6th consecutive month.

WHAT TO SELL

The Fed says it’s data dependent. If they actually are, economic data over the coming months should force their hand. Interest rates will rise faster than the two or three currently expected by investors in 2017. That will be unequivocally bearish for Long-Term Treasury bonds (TLT). We say sell them.