Indicators Talking Inflation: The Yield Curve Is Not Listening

I think it is crazy that the 30 year and 10 year US treasury bond/note yields differ by only eight basis points. (5.18% and 5.10% respectively for on the run and 5.20% and 5.13% according he average bond) The difference between these two longer maturity bonds should be an indicator of fears about future inflation/devaluation of the dollar.  Right now, the bond market is telling you it has no fear of inflation.  In contrast, rising prices of gold, silver, copper, housing, taxi fares, gasoline, oil, firewood, contractor salaries, scrap metal, medical expenses and the decline in the US Dollar relative to almost every currency in the world tell you that those markets fear inflation/devaluation is around the corner.  It would seem to me that someone is going to be wrong; I fear that someone is going to be the bond investor. (interesting technical picture here)

So what does this mean for my portfolio? I have many structural long positions in tax free municipal bonds.  I am hedging these long muni bond positions with shorts in 10 and 30 year US Treasury Futures. For this hedge, I use longer dated (September or December) – less liquid - futures so that I am not tempted to trade them. Yesterday and today, I increased the size of that hedge.   In my IRA I am not significantly weighted in any long term bond funds except inflation indexed bonds (TIP).  If I need a bond investment it is in a shorter term bond ETF (Exchange Traded Fund) like SHY.

When the bond market gets the message that inflation is here and that the fed cannot do anything about it without choking the economy to the point of near depression long bond yields have to rise significantly (and that means that bond prices drop).

Disclosure:

I am short ZNU6 and have been for months(10 year), ZBU6 (30 year) bond futures., I am long various muni bonds and am only buying money market muni funds or new issue muni bonds with maturities less than three years.  I own a few closed-end muni bond funds trading at discounts of greater than 10% to NAV (Net Asset Value). But more on closed-end muni bond funds in another entry.