In the tumultuous financial landscape of recent times, retail investors find themselves at a crucial juncture, adapting to an environment where inflation is no longer a dormant giant.

As US yields embark on an upward trajectory, it is imperative for these investors to recalibrate their strategies, aligning themselves with the imperative of hedging against inflation.

Despite transient rallies in bonds, the undeniable downward trend in Treasuries cannot be overlooked.

Understanding the New Normal

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For decades, discerning between real and nominal levels was almost a non-issue. However, as inflation rears its head, both professional and retail investors are compelled to navigate these uncharted waters, learning from countries like Argentina, which have long battled unruly inflation.

Investors from these regions are all too familiar with the deceptive nature of official currency values and the havoc rampant price growth can wreak on the real value of financial assets.

The Initial Response and its Evolution

The onset of US inflation in 2021 marked a paradigm shift, sparking a surge in interest towards real assets and their proxies, including commodities, energy, and industrial stocks. While this trend has experienced a slight decline, it is crucial to acknowledge that a return to a low-and-stable inflation regime remains a distant prospect.

Adapting Investment Strategies

In response to the evolving economic climate, households are adjusting their investment strategies, channeling funds into the largest commodity ETFs, showcasing a discernible rise this year. Additionally, the steady uptick in investments in ETFs of inflation-protected securities, after a peak in 2021 followed by a sharp decline, is a testament to the changing investor sentiment.

Perception and Expectation: Households vs. The Federal Reserve

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A glaring divergence is evident between the long-term inflation expectations of households, as indicated by the University of Michigan’s survey, and the predictions of the Federal Reserve. Households foresee a more inflated future than what is projected by the Fed or implied by the market, based on breakeven rates and CPI fixing swaps.

The Role of Term Premium

Historically, household inflation expectations have been a precursor to movements in the bond term premium, typically leading by a year. This premium is predominantly driven by market expectations surrounding inflation and its volatility. In the current cycle, the correlation between inflation expectations and term premium is poised to intensify, with households emerging as the de facto buyer of last resort for Treasuries.

The Transformation of the Treasury Market

As the Fed, US financials, and international players retreat from USTs, households stand as the sole absorbing sector. Positioned as the marginal buyer, they are inevitably inclined to seek higher yields, aligning compensation with the escalated inflation risks they anticipate and are proactively hedging against.

As retail investors grapple with the reality of inflation and its ramifications on their portfolios, it is evident that US yields are poised for further ascension. The persistent downward trend in Treasuries serves as a stark reminder that the financial landscape has undergone a monumental shift.

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Investors, now more than ever, must remain vigilant, learning from nations accustomed to inflationary woes and adapting their strategies to secure their financial future in an era defined by uncertainty and change.

With households taking a central role in absorbing USTs, their demand for higher yields reflects a prudent approach, underscoring the importance of hedging against the looming inflationary tide.

The journey ahead may be fraught with challenges, but with strategic adaptation and a keen understanding of the new normal, retail investors can navigate these treacherous waters, safeguarding their assets against the relentless push of inflation.

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