Still Lots Of Economic Firepower – February 27, 2023

A just-published report highlighted that the rally in equity markets since last autumn will be at risk if global bond yields continue to firm. Ominously, the short end of the U.S. and euro area yield curves have broken out, and 10-year German bond yields are on the verge of following. We have flagged these two possible breakouts as harbingers of higher Treasury yields and increased tensions in risk asset markets.

The recent rise in global government bond yields is being driven by signs of renewed vigor in global service sectors, particularly in the previously lagging euro area and Chinese/Asian economies. That, plus a resilient U.S. economy, bodes poorly for the inflation outlook once the current deceleration phase runs its course over the next six months.

Investors have chronically underestimated the economic foundations in the U.S. and euro area: both still have a huge pool of “excess” savings built up in recent years due to underspending (related to the pandemic) and related huge fiscal transfers. Both regions still have pent-up demand for services (especially for “experiences”), and a sizeable pool of savings in reserve with which to fund above-trend services spending growth.

Better global growth looms and will ultimately prove to be bad news for financial markets because inflation is far from being in hibernation.


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