Traders on the floor of the New York Stock Exchange

Source: The New York Stock Exchange

According to Carl Weinberg, chief economist at High Frequency Economics, inflation expectations are becoming detached from reality, which means that the markets may outplay the rise in US Treasury bond yields.

Global markets have been rocked in the past 24 hours after the yield on the 10-year US Treasury note surged above 1.3% for the first time since February 2020, while the 30-year bond also hit its highest level in a year. The yields move inversely to the bond prices.

Yields tend to rise with inflation expectations as bond investors begin to believe that central banks will take their foot off the gas and reduce asset purchases. Higher returns can also translate into greater debt servicing for large companies, which tends to upset stock markets as traders reevaluate the trading environment.

Market expectations for US inflation rates have reached their highest level in a decade, driven by increased prospects for a large fiscal package, advances in vaccine adoption, and pent-up consumer demand.

However, Weinberg suggested that the expected spike in inflation expectations, given economic realities, is a red herring.

“I think that is the big problem right now, the unbundling of inflation expectations. An important element of inflation is wages and people who receive higher wages in a time with still very high unemployment and still much economic downturn.” He told CNBC’s “Squawk Box Europe” on Wednesday.

“That would be a sign that an inflation process has started, but we don’t see any sign of it. What we see is the perception that energy prices are fueling inflation.”

Weinberg alleged that members of the public experiencing higher fuel prices at the pump may behave as if inflation was occurring, citing a sharp rise in Brent crude oil price since November as the catalyst.

“We may see as much as 2.75 percentage points adding to a rise in CPI (consumer price index inflation) and headline inflation in people’s eyes. But a rise in CPI is not inflation and this is not inflation,” he told The Forecast that the base effect of rising energy costs and the increased inflation expectations will work “out of the numbers” by the end of the year.

“We are returning to normal from a depressive base. We are not in an area where true inflation is in sight.”

The rise in inflation will “not last”

Weinberg’s skepticism was confirmed by UBS Global Wealth Management’s chief investment officer, Mark Haefele, who said in a statement Wednesday that while inflation is likely to spike in the short term, there are no signs of sustained price pressures forcing the US would Federal Reserve to withdraw their incentive early.

“Last year’s US fiscal packages counteracted a collapse in private sector activity to bring the economy back to pre-Covid-19 levels. The new package will boost an economy that is still below potential and spending will be spread over a couple of years, “said Haefele.

He suggested that much of the short-term inflationary pressures are due to unusual disparities in supply and demand caused by the pandemic, which should go away as economic activity normalizes.

“Overcapacities in the economy are also likely to limit the ability of companies to pass on higher input prices to consumers,” said Haefele.

“The fact that short-term market inflation expectations are higher than longer-term expectations is consistent with the view that inflation will not continue to rise.”