Stock markets are betting that vaccines together with a new US stimulus injection will be the shot in the arm needed for the global economy. The data from Israel is certainly encouraging.
There is a sting in the tail – rising Treasury yields. To be fair, 1.19% for the 10-year (Friday’s close) is hardly going to tip equity markets over. But further down the road the risks cannot be discounted. Valuation metrics, such as the reverse yield gap, will become stretched if yields rise in response to concerns over a loose fiscal policy. The break-even rate for 10-year Treasuries has already risen to 2.21%, and indexed-linked yields may start to climb.
Some measures of inflation (the CPI) may be underestimating the true increase in prices. The official indices could be up to 50 basis points too low. Higher cost pressures due to Covid-19 have not been fully reflected in the CPI.
Of course, these distortions are less applicable for the consumption deflator where the weights adjust automatically.
Either way, the Treasury market recognises that the short-term risks for inflation are higher: the break-even curves have all turned negative this year.
Summary
• The news on vaccines is still good
• The rise in yields needs watching
• Valuation metrics will get stretched
