What if inflation returns?

Synopsis

Just about everyone thinks that interest rates will remain very low indefinitely. A chart of 10-year treasury forwards indicates that investors expect these rates to stay near all-time lows. This situation is significant because low interest rates justify today's high stock prices, compelling investors to buy stocks for returns. However, inflation poses a potential threat to this consensus, as it could drive bond yields up. The COVID-19 crisis has currently led to deflation, but the massive monetary and fiscal stimulus injected into the U.S. economy raises concerns about future inflation. A spike in inflation was noted in July, although many investors dismissed it as a temporary issue. Some economists warn that once the crisis subsides, the combination of government stimulus and returning demand could trigger high inflation. This scenario is particularly concerning for stock market investors, especially those invested in high-growth tech stocks like Amazon, Apple, and Netflix, which have significantly driven market rallies. If inflation rises, these markets may face considerable challenges.