Macrocast

Contrasted Expectations

Key points 

  • Market-based US inflation expectations have stopped climbing, in contrast with the message from businesses and consumers, contributing to a stabilization of the US bond market. We think this is a pause and that the US curve will steepen further as the credibility of the Fed’s Average Inflation targeting strategy is questioned.

The US bond market has stabilized over the last two weeks around 1.70% for a 10-year treasury note after the significant rise in long-term yields triggered by Joe Biden’s victory. Market-based inflation expectations have stopped climbing, in contrast with the message sent by businesses and consumers alike in the recent surveys.
Just as we explored the information content of businesses inflation expectations a few weeks ago, this time we turned our gaze to households. The latest Michigan survey suggests that consumers’ inflation expectations for the next 5 years have rebounded to their long-term average for the first time since 2014. We suspect this can be explained by the recent public debate around the risks of “overheating” the Biden emergency stimulus could trigger. The frequency of queries on the Internet reflects the emergence of an “inflation anxiety” in the US.  These phenomena tend to be self-fulfilling. We show that in a simple model, the Michigan survey, alongside the unemployment rate, is a good predictor of actual core consumer prices.  With the two variables pushing in the same direction now, and business survey continuing to reflect a rise in price pressure, an acceleration in core inflation is very plausible in the coming months, beyond the expected base effects. This will raise questions on the credibility of the Fed’s Average Inflation Targeting framework, pushing real rates up.
This is one of the key elements which make us believe the current stabilization in US yields is merely a pause and we continue to expect the 10-year rate to hit 2% in the coming months. The market is probably taking stock of the risks of yet another wave of Covid before collective immunity is reached, despite the speed of the US vaccination programme. The prospect of tax hikes funding at least partly the newly unveiled investment plan by the US administration may also curb market enthusiasm for Biden’s fiscal activism. But even if the Democrats have their way on this – and contrary to the consensus view until last week, it seems the Senate could use the “reconciliation process” more than once during a fiscal year, reducing the need for bi-partisan support – the tax hikes would be back-loaded, and the supply of US treasuries would rise significantly anyway. True, by year end the US economy may face a complicated moment when the emergency stimulus fades and the mechanical effect of the post-pandemic reopening is absorbed, because the investment plan is unlikely to provide the same impetus. Yet, in the months ahead, the coincidence of higher inflation and higher debt issuance still creates some space for another curve steepening.

This document is for informational purposes only and does not constitute investment research or financial analysis relating to transactions in financial instruments as per MIF Directive (2014/65/EU), nor does it constitute on the part of AXA Investment Managers or its affiliated companies an offer to buy or sell any investments, products or services, and should not be considered as solicitation or investment, legal or tax advice, a recommendation for an investment strategy or a personalized recommendation to buy or sell securities.

It has been established on the basis of data, projections, forecasts, anticipations and hypothesis which are subjective. Its analysis and conclusions are the expression of an opinion, based on available data at a specific date. All information in this document is established on data made public by official providers of economic and market statistics. AXA Investment Managers disclaims any and all liability relating to a decision based on or for reliance on this document. All exhibits included in this document, unless stated otherwise, are as of the publication date of this document. Furthermore, due to the subjective nature of these opinions and analysis, these data, projections, forecasts, anticipations, hypothesis, etc. are not necessary used or followed by AXA IM’s portfolio management teams or its affiliates, who may act based on their own opinions. Any reproduction of this information, in whole or in part is, unless otherwise authorised by AXA IM, prohibited.

Neither MSCI nor any other party involved in or related to compiling, computing or creating the MSCI data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of such data. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in or related to compiling, computing or creating the data have any liability for any direct, indirect, special, punitive, consequential or any other damages (including lost profits) even if notified of the possibility of such damages. No further distribution or dissemination of the MSCI data is permitted without MSCI’s express written consent.

This document has been edited by AXA INVESTMENT MANAGERS SA, a company incorporated under the laws of France, having its registered office located at Tour Majunga, 6 place de la Pyramide, 92800 Puteaux, registered with the Nanterre Trade and Companies Register under number 393 051 826. In other jurisdictions, this document is issued by AXA Investment Managers SA’s affiliates in those countries.

In the UK, this document is intended exclusively for professional investors, as defined in Annex II to the Markets in Financial Instruments Directive 2014/65/EU (“MiFID”). Circulation must be restricted accordingly. 

© AXA Investment Managers 2021. All rights reserved