The yield curve — the difference between short- and long-term interest rates — is a measure of the market’s optimism. Higher long-term rates reflect an expectation that growth is on the horizon and that central banks’ policy rates will be higher in the future. When borrowing for the long term costs less than the short term, however, it reflects a potential recession and the loose monetary policy that comes with it. This week’s steepening shows that markets were given a big reason for thinking there is hope of a return to normality: a fairly effective coronavirus vaccine, plus confirmation that Democratic candidate Joe Biden had won the US presidential election.
This has put the long-mooted “reflation trade” back on the table. A vaccine may allow a faster resumption of normal economic activity than first thought and with it a recovery in revenues for companies shut down by the coronavirus pandemic. Share prices of the most affected companies rocketed after results from the successful trial of a Pfizer/BioNTech vaccine: equity in IAG, the parent company of British Airways, rose by more than a fifth on Monday; Airbus increased by 16 per cent.
A steeper yield curve has also helped banks, which profit by borrowing short term and lending long; the share prices of JPMorgan Chase and Bank of America both jumped by 15 per cent on Monday. The winners of the pandemic, however, were this week’s relative losers — retailer Amazon as well as video conferencing software maker Zoom.
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There are reasons for caution. It will take months — at least — to inoculate everyone and many will opt out. For the moment, Europe and the US appear to have lost control of the virus and the economic damage will be with us even once a vaccine is rolled out. Workers that have been furloughed or placed on short-time working schemes may soon become unemployed as companies have to find some way to deal with higher debt burdens.
Stronger growth is a double-edged sword for investors, too. Higher inflation — oil rallied on the news of a vaccine — would undermine the assumption that low interest rates, and cheap finance, are here to stay. Tech company valuations are so high partly because of the magnifying effect of low rates on growth stocks, while the popularity of Spacs — so-called blank cheque companies that short seller Muddy Waters this week called a “money grab” — similarly owes much to monetary policy.
Reflation may be overdone. Hopes of strong growth after the 2008 crisis did not come to much for reasons that have not changed: beating the pandemic will do little to boost productivity or undo the ageing of rich countries. Perhaps for this reason markets have pared back their gains over the past few days. Ultimately, though, investors, and the whole of the world, have more reason to be optimistic today than for many months.
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