LONDON (Reuters) – Just as long-dormant inflation finally rears its head again, there are some signs that financial markets may already have overestimated the impact – or at least the response.

One of the biggest fears of the year for global investors has been that a policy-supercharged, post-pandemic recovery of major economies seeds an inflation surge that spooks central banks into tightening credit well before they currently suggest.

While there’s some argument for holding stocks during an inflation scare, the worry is central banks get spooked – lifting borrowing costs and dragging on growth and earnings estimates and rethinking discounted valuations for growth and technology stocks.

With base effects from last year’s energy and price crash now starting in earnest amid considerable COVID-related supply-chain bottlenecks, U.S. consumer price inflation bounced back above 2% for first time since the pandemic in March – topping forecasts for its highest in almost three years at 2.6%.

And yet after a couple of months of tantrums and rising bond yields in anticipation of the coming price jump, Tuesday’s CPI data release passed off with barely a flicker.

The Fed’s relentless message that temporary inflation spikes are to be expected and that it will not tighten policy until evidence of a recovery is clear and complete seems to be sinking in.

With central bank eyes mainly on inflation that excludes volatile food and energy prices, the March “core” rate of just 1.6% will hardly ruffle feathers in Washington yet.

To be sure, there will be many more months of these sparky price headlines. The oil price nadir in 2020 was on April 22 and so next month’s inflation headline readings will have to factor in a quadrupling of crude prices since then.

But there are already some signs the recent bounce in U.S. yields may already be enough to tempt investors back to bonds – partly to brace for any pause or correction in record high stocks and any spluttering of the vaccine-led recovery or a stalling of mooted fiscal spending splurge.

Another way to look at it is the extent to which Fed tightening is already priced or expected.

Money markets have for several weeks now almost fully priced a quarter-point Fed rate rise by the end of next year – and almost 100 basis points before the 2024 date when the median of Fed policymaker forecasts currently sees a first liftoff. (Graphic: Markets’ inflation pricing, here Bank of America chart on survey showing “short Treasuries” as crowded trade, ) SHARP ELBOWS

That pretty aggressive stance was underlined by this month’s global fund manager survey by Bank of America.

Bearing in mind that it polls investors around the world and also that the question was non-specific about key policy rates per se, almost 60% of respondents said they saw higher short-term rates within 12 months.

That’s almost eight months before even angst-ridden money markets say “go” and the highest reading in more than two years.

Reinforcing that were signs that any funds wanting to bet on higher yields may find themselves late to the game.

Almost 10% of the April survey’s respondents reckoned “Short U.S. Treasuries” – essentially betting on higher bond yields – was the most crowded trade on the street.

It was identified as one of the top five crowded trades, including regular moans about long tech stocks and bitcoin and more recently the crush into so-called environmental, social and governance (ESG) investments.

None of the investors polled in March thought “short Treasuries” needed much elbow room at all.

So has the great 2020 yield surge gone far enough already?

Perhaps the very assumption of such aggressive policy tightening has itself allowed investors some reassurance that long-term inflation expectations will remain in check and March headline CPI inflation may prove the best long-term assumption.

If central banks want to and are successful at pushing back that market pricing, it’s possible yield curves may steepen again at the long end – absent an economic stumble itself. So maybe everyone’s happy right here at the moment.

Even though 10-year nominal Treasury yields are 1.66%, “real” inflation-adjusted yields are still negative to the tune 0.68%. Sub-1% 5-year yields have equivalent as low as -1.83%.

However, 30-year real yields from the inflation-protected bond market are back in positive territory again and hold nominal yields as high as 2.34%.

This meatier long bond rate, together with this year’s unexpected dollar strength, is allowing many overseas fund managers to once again consider Treasuries as ballast in portfolios that will guard against any sudden stock market correction, temporary or not.

“Flexibility is key,” wrote M&G Investments macro fund manager Eric Lonergan, adding that bulky holdings of cash, diversified world equities and 30-year Treasuries were now necessary to navigate a bumpy year ahead that could easily see a 15%-20% retreat in stocks at some point.

“If something goes wrong, that’s your insurance policy.”

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