Reflation Loses Air

Ryan Sitarz

Ryan Sitarz, CFA, CFP

Portfolio Specialist

2021 has been marked by what seems to be higher prices everywhere one looks: lumber, coper, groceries, cars, gas, the list goes on. It’s not surprising that we have seen the YoY change in the consumer price index (CPI) reach in June the highest level in over 30 years.

Many worry that a consistent and rapid rise in prices is our future. The latest trends in the bond market should offer some degree of comfort in that recent movements suggests broad based inflation should moderate. The 5-year, 5-year forward, the Fed’s preferred measure of inflation expectations, has pulled back from its mid-May high of near 2.5% to just above 2%. This seems like good news. However, on the flip side, growth expectations are also moderating. The 2-10 U.S. Treasury spread, a widely followed indicator of economic growth, has flattened significantly over the last two months, tightening from 150 bps down to under 100 (figure 1). The curve steeped in dramatic fashion at the start of the year, but has since retraced, reflecting an outlook of more subdued growth and inflation, as some market participants point to COVID cases back on the rise.

While investors are generally dismayed to see prospects for future economic growth dampen, if it means a higher probability of central banks staying accommodative, it’s difficult to say what the impact will be on stocks going forward. Bad news, good news?

Figure 1. 2 Yr - 10 Yr U.S. Treasury Spread
Figure 1

Source: Bloomberg, John Authors, as of 7/20/21

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