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The retreat in US Treasury yields over the past month or so seems at odds with the US economy’s fundamentals, and economists at Capital Economics doubt that it will be sustained. Their forecast that the 10-year yield will end 2021 well above its current level implies that US equities will fail to make further gains this year.

See:  S&P 500 Index to hit new record highs as markets bank on Fed remaining on hold – UBS

Treasury yields, inflation compensation and US equities

“While we forecast that the Fed will keep rates on hold for a few years yet, we expect higher inflation to prove more persistent than many expect. We think this will lead investors to judge that a greater degree of tightening will be needed further down the line, pushing up long-dated bond yields. This informs our forecast that the US 10-year yield will end 2021 at 2.25%, up from just below 1.50% at present.”

“We suspect that a jump in yields on that scale would knock some of the wind out of the US stock market’s sails, particularly when valuations and analysts’ expectations for corporate earnings are already high. Our forecast is that the S&P 500 will end 2021 at 4,200, a bit below its current level.”

“Higher bond yields might also help the rotation in stock markets to get back on track following its recent pause. After all, higher yields are often a boon for the financials sector in particular and would probably hurt the valuations of ‘longer-duration’ growth stocks more than those of value stocks.”