Something interesting happened in the first week of January.

Bond market participants started to form a view that inflation was going to be higher in the short term, versus the long term.

If you look at the breakeven inflation chart below, it shows that from 5 January onwards, bond market participants felt that average inflation expectations over the next five years were going to be higher than over the next ten years.

This inflection, or bring-forward of inflation expectations took less than two months to occur from the time of the announcement of the first vaccines, in November 2020.

While it might have something to do with buying by the Fed, the better answer is that the market started to price in near term inflation as a result of expected price rises in oil, commodities and building products as well as pent-up demand for services and crowd experiences - under an optimistic vaccine roll out and global reopening case.

Given the vaccine roll outs have been slow, and given increasing COVID cases in India and Europe, we may have to wait until the second half of the year to fully understand whether these short term inflation expectations will translate into sporadic pent-up inflation, or whether we get nominal growth plus inflation, or reflation.

The latter would mean more pressure on Fed Chair Powell to decelerate bond buying, and in time, step up interest rates.

The former would mean a still buoyant equities market.

Either way, in the meantime, traditional bond/equities markets are likely to go sideways (with equities priced for perfection) but with a historically low cost of capital and an uncertain growth outlook due to the extended recovery runway, M&A activity is likely to accelerate.

When it becomes difficult or risky to bake your own blueberry pie, try eating someone else’s.

See you in the market.

Mike.