Optimists forecast prosperity to rival the 1920s. Those years blended new technology, booming stocks and a scandalous US president, all in the wake of a pandemic. Pessimists fear soaring inflation will be part of the package due to a huge state stimulus. Yet US bond yields, adjusted for expected inflation, reveal little anxiety. Aptly so: inflation was not a problem in the US during the Jazz Age.

US “real” bond yields have plumbed the depths lately, though mostly in shorter maturities. These rates are calculated by subtracting the implied inflation rate in the yields of US Treasury inflation-protected securities (TIPS) from those of regular Treasuries. While yields on the TIPS point to prices rising as much as 2.4 per cent annually, nominal yields for the same maturities hint at little if any inflation. In fact, the difference between the two yields hint at deflation. Part of the reason for this is Federal Reserve bond purchases, intended to keep nominal interest rates down.

So far that policy has worked. US bonds still offer a low, positive nominal return. Meanwhile, US consumer price inflation crept back up to 1.4 per cent in December, compared with almost zero in May. But if bond markets feared a surge of inflation, one might have at least expected foreign investors to sell their US government bonds. But up to September, US federal debt held by them had increased in 2020, according to the Federal Reserve Bank of St Louis.

Lex charts on US real bond yields and what these say about the Roaring 1920s

Those expecting inflation have long been disappointed. Central banks have pumped liquidity into bond markets for more than a decade with little effect seen in the US, Europe or Japan. Inflation hardly troubled the US (or the UK) during the 1920s, either. US consumer price index increases averaged just above zero annually back then. There were a number of reasons for this, including productivity-enhancing innovations in transport (automobiles) and the electrification of leading economies.

In the 1920s, a low-inflation boom ignited a bull market that ended horribly in the 1929 Wall Street crash. Today, a technological revolution is already heavily factored into stocks. Equity investors have more to fear than bondholders.

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