Morning Notes — Bond Yield Forecast

Bond yields: Bond prices are in a developing bear market and yields are heading higher.  Globalization and technological changes have been weighing on inflation for two decades, but the past 12-years of disinflation was caused by specific events including: 1) the 2008 financial crises; 2) systemic deleveraging of the banking system; 2) China’s decision to de-lever in 2014; 3) US-China trade war in 2018 and; 4) a global pandemic in the spring of 2020. Each event was met with policy accommodation, culminating with unprecedented amounts of monetary and fiscal stimulus in the wake of Covid-19.  Biden’s recently proposed ~$1.9T fiscal stimulus package will probably shrink to something closer to ~$900B to get done, but would be the third major fiscal spending package in 12 months and the second in two months. And US money supply is already growing at +25.3% year-over-year.

Too much? Could expansionary fiscal spending under a Biden/Democrat-controlled Senate produce enough inflation to prompt Fed tightening and become a tail risk for equities? The Biden team expects to monetize its recently unveiled fiscal relief package through central bank asset purchases (similar to the CARES Act).  While this is likely acceptable as an emergency relief tool, the window for using central bank asset purchases is beginning to close.  An improving US economic outlook should narrow the output gap to a point where the Fed begins to taper by year-end.  Tapering isn’t tightening and a commitment to the zero lower bound over the next ~12-24 months means higher yields and curve steepening.

Specifically: We see 10-year Treasury yields rising toward ~1.45% later this year with curve steepening continuing to benefit cycle/value stocks.  And 10-year yields above ~1.45% could become problematic for broader equity multiples.