Are Stocks and Bonds Actually Agreeing with Each Other?

Stocks at new all-time highs, but the nominal 10-year yield well off its late-March peak (and real yields making all-time lows), suggest that these two markets have conflicting views of growth prospects. Bonds may be in fact more sensitive to the abandonment by the Biden administration of Modern Monetary Theory, that is, debt-financing huge spending programs. The 10-year yield topped the same day the administration announced that its next spending program would be tax-funded, which importantly deflects the bond markets estimates of the volume of future issuance and US credit-worthiness – and makes the enactment of such programs highly unlikely. This makes little difference to stocks, because at this point of diminishing returns debt-funded spending will not be very stimulative, and tax-funded spending definitely won’t be. Lower bond yields operate through the equity risk premium to make stocks more relatively attractive, so the ERP has mean-reverted close to the post-GFC mean from a record narrow with stocks still able to make new highs. At the same time, consensus forward earnings are being upgraded at a record pace, despite which this earnings season is already another record beat. Market-implied inflation expectations haven’t changed much, but that is significant – they’ve held steady during a surge of fearsome hot CPI prints, and helped the Fed stick to its “transitory” guns. A premature taper or lift-off is off the table.