Trader: The “Goldilocks Environment For Equities Is Here For A Long While Yet”

By Heisenberg

[biiwii comment: The perma-bull quoted below is correct in his interpretations of the yield curve (and Goldilocks), but I’d take issue with his view of timing. Also, it’s not just US fiscal policy that would drive inflation, it is global. What are the EMs telling us?]

More than a few commentators have pointed to the recent flattening of the curve as evidence that the reflation narrative has broken down completely.

And to be sure, the reflation meme is what’s driven the post-election “Trump trades”

StocksCurve

The question then, is why equities have yet to respond in any appreciably negative way. Well, here with his take is self-described permabull Mark Cudmore.

Via Bloomberg

Some gifts can be recycled. It’s the same with strategy views. On a very long-term basis, the flattening U.S. rates curve is a bullish signal for equity markets. And it still has a way to run.

  • August to December last year saw a sharp steepening of the curve, but the multi-year trend for a flatter curve is back on track
  • Based on data from the last 25 years, we appear to be a little past mid-cycle in the flattening process
  • The last two major flattening cycles (1992-2000, 2003-2006) coincided with significant bull markets for U.S. equities. The correlation makes sense intuitively, although the direction of causality can vary
  • A steepening yield curve implies that either inflation concerns are growing or that front-end yields are plummeting in reaction to a crisis. An inverted curve either signals that deflation is feared or that rates have been increased aggressively in the short-term to control already run-away inflation
  • A gently sloping upward yield curve is equivalent to the rates market giving monetary policy a thumbs-up
  • The Fed seems determined to raise rates. And why shouldn’t it? Financial markets are in robust health
  • Sure, there’s no sign of runaway inflation. And there’s not likely to be any time soon, which is why the curve should continue to flatten in the years ahead
  • This isn’t a short-term signal, but it does suggest that the long- term Goldilocks environment for equities is here for a long while yet
  • Some gifts just keep on giving. By way of proof, I offer this column, recycled from May 2016
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