The official blog of BNP Paribas Asset Management

Chart of the week – Inflation KISS*

Is there a disconnect between US bond and equity markets, with low yields on the bond markets reflecting pessimism about the growth outlook, while equity markets plough on merrily, advancing amid signs that demand for labour is keeping the job market tight and preserving the pressure for higher wages?

Exhibit 1: Dropping real yields – a bearish sign?

US real yields and equitiesSource: Bloomberg, US Federal Reserve, BNP Paribas Asset Management; data as of 17 March 2019 Real US Treasury yields, adjusted for inflation, have continued to drop, prolonging their slide from the last quarter of 2018. While the correlation between real yields and equities is typically low, a look at the correlation between inflation expectations and equities makes more sense. This is because inflation expectations often move with crude oil prices and both reflect the prospects for economic growth. Growth drives demand for oil and dearer oil boosts inflation.

Exhibit 2: What matters for equities is inflation expectations

US real yields and equities Source: Bloomberg, US Federal Reserve, BNP Paribas Asset Management; data as of 17 March 2019 So low bond yields and higher equity prices are consistent because inflation expectations have been rising. With inflation expectations still (slightly) below average, we believe there is room for further upside for the S&P 500 index.
*KISS: keep it simple stupid; the KISS principle states that most systems work best if they are kept simple rather than made complicated; therefore, simplicity should be a key goal in design, and unnecessary complexity should be avoided. Also see In a way, the acronym is reminiscent of the (It’s) the economy, stupid" phrase of the 1992 Clinton vs. Bush US presidential campaign. For more posts by Daniel Morris, click here > For more charts of the week, click here >

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