The markets are challenging the central banks' attempts to repress interest rates. Yield curves in the U.S. and Europe are steepening. The 2s-10s yield curve slope for the U.S. is the steepest in three years, as shown below.

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Some prefer to focus on the relationship between the 3-month interest rate and the 10Y rate (instead of 2s, 10s). The second most popular measure of yield curve slope is shown below. Note, it tells the same story as the first chart.

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What does the steeper curve tell us?

Yield curves tend to steepen either due to:

1. Improved growth prospects,

2. Increased inflation risk,

3. Increased credit/default risk and/or China liquidating its reserves to satisfying its current shortage of dollar funding.

Most believe the steepening this time is due to inflation. In fact, inflation is not the primary concern, it is – that dreaded 1970’s word – STAGFLATION. The chart below shows that U.S. inflation is expected increase (from 0.3% to 0.97%) but 1% is still far below the Fed’s targeted level of 2%.

Note that inflation is equivalent to a de-valuing of the currency. Increased default/credit risk is another way to de-value money through a reduction in the "full faith and credit" spectrum. In other words, stagflation could result from either inflation or credit concerns.

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With sovereign debt growing at a staggering speed, due to the corona virus, and a record level of corporate debt going into the slowdown, the market is starting to grapple with the prospect of coming stagflation (slow growth and high inflation).

MMT (Modern Monetary Theory) is based on the premise that debt levels do not matter, but the markets appear to disagree. The ECB’s recent decision to expand its bond buying program may have been the tipping point.