Market Outlook: Bonds and bitcoin hint at bubble territory

Yield hikes start to worry

Having banged the inflation drum for some months, last Monday I noted that everyone’s suddenly talking about it. Now rates are really starting to worry. We are witnessing a sharp sell-off in rates with yields moving aggressively higher, which could spread into trouble in other asset classes like stocks, foreign exchange and even cryptos. This creates problems mainly because of just how quickly the move is happening. Treasury yields had their biggest gain in three months on Tuesday, with spread on ten year treasuries rising 9 basis points to hit the highest since February above 1.3 per cent. The 2s10s spread widened to 1.18 per cent, the widest since 2016. Breakevens keep moving higher – inflation expectations are becoming unanchored.

I’ve expounded many times before on how the vast amount of pro-cyclical fiscal stimulus, ultra-loose monetary policy, pent-up demand and a savings glut will create a powerful inflationary impetus this year. I’ve also stressed many times that this environment, coupled with the Fed’s new average inflation targeting – which explicitly lets the economy run ‘hot’ –  could lead to inflation expectations becoming unanchored, just as they did in the 1970s. If inflation does start to move up the Fed may need to act. Allowing inflation to take off could eat away at real gains, but it will also help erase deficits. The question the Fed – and Treasury – need to ask themselves is whether deficits matter. 

Knock-on impact on stocks

The ProShares UltraShort 20+ Year Treasury ETFs, which tracks double the inverse (-2x) of the daily performance of the US Treasury 20+ Year Bond Index for a single day, is exploding higher and is now up almost 20 per cent this year. Vix March futures also advanced during a mixed session on Wall Street that left the Dow up 0.2 per cent but the S&P 500 flat and small cap Russell 2000 0.7 per cent lower. Higher rates hit bond proxies like real estate, utilities and health, whilst the chief reflation trade winners, energy and financials, rose. 

Stocks in Europe are sliding a touch this morning after Tuesday’s pause. Concern about interest rates moving up as quickly as they are is starting to worry some investors. It’s not the absolute yield that matters but the rate of change which is catching investors off guard. UK inflation nudged up to 0.7 per cent in January from 0.6 per cent in December as the cost of furniture and household goods, restaurants and hotels, food, and transport all rose. This is just the start though as the roaring 20s leads to roaring inflation by the…