Chart of the Week

GOLDILOCKS GOOD. BOOM BAD?

At face value, anything that reduces the risk of a US recession should spell good news for the stock market and other risk assets.

However, the potential for a spike in bonds yields rises as the growth outlook improves. And, as we saw in 2021/22, that tends to be a headwind for equity investors.

There are two potential catalysts for much higher US bond yields.

The first is a continuation of fiscal largesse as this would prompt the bond vigilantes to come out in force against the government’s excessive debt use.

The second would be a resurfacing of inflationary pressures. This time likely borne of a strong economy and demand surge, rather than supply bottlenecks.

The chart below shows the close link between market-based inflation expectations (red line) and the 10yr Treasury yield (blue line).

For now, inflation expectations remain anchored, but the risks are skewed to the upside and we could well see the 10yr yield trade comfortably above 5% this year.

However, any spike should be short-lived. The US government needs low rates to help it refinance around U$10trn of borrowing this year so any disorder in fixed income markets is likely to be met with yet another QE-style program.