Stocks and bonds are heading for an inflation scare

There is talk of the ten-year US Treasury bond yield hitting 2%, which would be enough to threaten stock prices.

Markets are heading for an inflation scare, says James Mackintosh in The Wall Street Journal. Until recently the “dominant” assumption was that the US was on track for a short-term jump in inflation, but that the US Federal Reserve would step in with interest rate hikes if things got too heated. Yet a majority of central-bank policymakers say that they intend to keep interest rates pinned close to zero until 2024, even as the US economy begins to boom. The Fed just doesn’t care as much about fighting inflation as it used to. When markets wake up, expect yields on long-dated Treasury bonds to spike.

Ten-year Treasury yields recently broke through the 1.7% mark, their highest level since the pandemic began. Still, that should be kept in perspective: the ten-year yield was trading above 3% as recently as 2018. Higher bond yields make stocks a less appealing investment. It’s enough to make you nostalgic for the “bond vigilantes” of the 1980s, says Randall Forsyth in Barron’s. Back in the days when “this band ruled the markets”, they had investors and governments quaking in their boots. In October 1987 a sudden spike in long-dated Treasury yields “collided with a richly valued market”, sending the Dow Jones plunging 22% in a single day.

Fed chair Jerome Powell continues to insist that only a “disorderly” rise in Treasury yields would spur the Fed into action, says Cormac Mullen on Bloomberg. 

Bond traders see that as a “green light to test his resolve” and now talk of the ten-year yield hitting 2%, which would probably be enough to threaten stock prices. This back and forth between the Fed and the bond market has the “ominous” feeling of a “car crash in slow motion”.

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