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Some investors are worried about rising field yields and its impact on the continued post-pandemic recovery. Lee reports that BOS has observed real yields move from -1.0% to about -0.65% in recent months. Yet such a trend, he comments, is typically driven by stronger economic prospects and will spell good news for equities, since higher growth in corporate earnings and falling equity risk premium outweighs the negatives of a higher discount rate.
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“Our view remains that the Fed will not taper QE in 2021 and will not hike until 2024,” pronounces Lee, who notes that his base case reflects Fed thinking. For equity markets to bottom out decisively, says Lee, markets must put away their fears of inflation and bond market volatility. The odds of this happening improve as yields rise, with the Fed likely to pour cold water on rising yields as they approach 2% to ensure an orderly recovery. Markets are also pricing in excessive interest rate hikes, with investors expecting the scenario of one 25 basis point hike in 2023 and at least three by end-2024. In any case, liquidity remains abundant, with excessive deposit accumulation in US banks now near record levels. Lee sees this as a source for continued demand for bonds. Banks are obliged to match the duration of their liabilities even as balance sheets expand due to strong quantitative easing measures from the Fed and subdued loan growth. Further liquidity is expected as congress moves to pass a US$1.9 trillion fiscal stimulus by mid-March.