1. Biden's fiscal stimulus policy strengthens the stimulus to the demand side of the United States.
Obviously, from the content of the plan, the Biden government's fiscal stimulus mainly subsidizes residents' cash income by increasing government debt. This will undoubtedly stimulate the demand side of the US economy. The current supply side of the US economy is also performing well. In February, the US Markit manufacturing PMI was 58.5, and the service PMI was 58.9. Both are quite strong. This shows that as the process of vaccination in the United States has accelerated and the spread of the epidemic has declined, the supply side of the economy has also begun to go on track. When the supply side of the economy is on the right track and the demand side is facing strong stimulus, there is no reason for inflation expectations not to rise. Therefore, the Biden administration’s fiscal stimulus policy will gradually be brought under control in the United States, and when the economy begins to recover, it will provide strong support to the US economy. As a result, the financial market has produced strong inflation expectations.
2. The expected increase in inflation will lead to an increase in US Treasury yields.
From the perspective of bond investment, bonds are bought because they want to earn interest. But what investors earn is not only the nominal interest brought by the bonds, but the actual interest after the nominal interest is excluding the inflation. Because inflation means currency depreciation. What investors need is assets that can outperform currency depreciation. Therefore, the actual interest excluding inflation is the criterion for the investor's return on buying bonds (actual interest = nominal interest-inflation rate). Prior to this, because of the quantitative easing in the United States, the yield on US Treasury bonds was very low. In April last year, the 10-year US Treasury bond yield was just over 0.5%. Before January this year, it was also below 1%. But obviously, if everyone's inflation expectations rise, this level of nominal interest is likely to be overtaken by the rising inflation rate. Therefore, at this time, US Treasury bonds are no longer attractive. It must be sold as people's inflation expectations rise.
From the perspective of supply and demand in the Treasury bond market, most of the funding source for the Biden government's $2 trillion stimulus policy will be to increase the issuance of US Treasury bonds. This is bound to increase the supply of the US Treasury bond market. However, under inflation expectations, there is a high probability that the Fed will not increase the supply of money. Then, this is tantamount to increasing the issuance of national debt while the money supply remains unchanged. Money is limited, but there are more borrowings. Then, the interest on borrowing can only be higher. Therefore, without further easing by the Fed, the US government's increase in the issuance of treasury bonds will itself push up the market interest rate of treasury bonds.
3. The rise in the Treasury bond yields led to a decline in the stock market
Treasury bonds are risk-free assets. Stocks are risky assets. In terms of pricing principles, the rate of return on risky assets = the rate of return on risk-free assets + risk premium. Therefore, when the rate of return on risk-free assets rises, the rate of return on risky assets also rises. When the amount of income remains unchanged, an increase in the rate of return means a decrease in the price. Therefore, when US Treasury bond yields rise, the US stock market also falls. The volatility of US Treasury bond yields also means the volatility of global dollar liquidity. Therefore, when US Treasury bond yields rise, global Treasury bond yields and risk asset prices will also follow the United States.
4. Capital flows to bulk commodities, leading to rising commodity prices
It is precisely because of inflation expectations that the prices of commodities such as London copper futures, aluminum futures, New York copper futures, platinum futures, and other commodities are highly consistent with the US 10-year Treasury bond yield. It shows that funds flow into the commodity futures market driven by inflation expectations.
5. Inflation expectations are derived from fiscal stimulus, but the currency has not been more accommodative, so gold fell.
But this time, there is a strange place: Why did inflation expectations rise, but the price of "gold", a well-known product that fights inflation, has fallen? The reason is that gold is the most stable asset in asset value, and it is fighting against currency depreciation. If inflation is caused by currency oversupply, then the rise in the price of gold against currency depreciation will also combat inflation. However, if inflation is not caused by currency depreciation, then gold will not have an appreciation effect against currency depreciation. Therefore, it will not follow the rise in inflation. And the increase in inflation expectations this time is not caused by the oversupply of currency. The Fed's quantitative easing policy to fight the epidemic recession has been reflected in the previous gold price. And this time the inflation expectations are due to the fiscal stimulus policy of the US government. The Fed did not loosen money again for this reason. Therefore, the total amount of base money has not changed. Hence, the price of gold will not rise against the issuance of currency. On the contrary, because funds need to adjust the asset layout according to inflation expectations, liquidity transfer has occurred. As the most liquid asset, gold will sell off to raise funds to invest in the commodity market. Therefore, this time inflation expectations have risen, and gold has fallen. The reason is that this inflation is not caused by currency issuance, but by fiscal stimulus and economic recovery.
