Bassanese Bites: Dot plot showdown – March 15 2021

Global markets

Global equities managed to shrug off further upward pressure on bond yields last week, as the combination of strong economic growth yet tame inflation results buffeted investors.

The S&P 500 Index rose 2.6% even as U.S. 10-year bond yields lifted 6 basis points to 1.63%. The U.S. February consumer price inflation (CPI) outcome was no worse than expected, with core annual inflation holding at 1.4%. Bond markets were also pacified somewhat by reassuring comments from the European Central Bank to the effect that it would step up bond buying to contain any destabilising rise in yields. Contrary to fears, key 10-year and 30-year U.S. Treasury bond auctions met reasonable demand, especially the former.

That said, other data suggests the global economy is roaring back with added fiscal policy stimulus throwing petrol on the flames. U.S. weekly jobless claims dropped to 712k last week from 754k, suggesting labour market improvement is reaccelerating after the Xmas/New Year COVID third-wave lull. Meanwhile, U.S. President Biden’s $US 1.9 trillion stimulus bill was signed into law, meaning around 85% of households will soon start receiving one-off payments of up to US$1,400. The OECD reckons this stimulus could add around 3% to U.S. economic growth this year, which is why it upgraded its U.S. 2021 growth forecasts from a strong 3.2% to a blistering 6.3% in last week’s updated Economic Outlook.

Can all that growth take place without adding to inflation? The Fed thinks so, but the bond market is not so sure. As evident in the chart below, the result is that the market is now pricing in the beginning of Fed policy tightening by mid-2022, whereas virtually all voting Fed members reckon it won’t happen until 2023 at the earliest. Were the market as sanguine as the Fed, my modelling suggests U.S. 10-year bond yields should not push much past 1.5% – which would be a relief for Wall Street. While I side with the Fed, how this showdown plays out over the short run remains to be seen, as U.S. growth data is likely to ramp up in the months ahead and, as alluded to last week, annual U.S. consumer price inflation is also likely to step up for at least a few months due to the base effects of very low COVID-related readings around this time last year.

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