The global economy is getting stronger. The inventory correction in global manufacturing is over. The US housing bust is not feeding through into a US consumer slump or even a generalized curtailment of credit availability. And as long as the doughty US consumer is experiencing rising net worth and firm wage gains, there is no reason for consumption to collapse.
Europe is booming. Japan, where the signs are more mixed (output, exports, investment and jobs are strong but wages are weak), will also boom before the end of the year.
So it is no wonder that bond markets have had a wake-up call. But what exactly is the US bond market discounting?
The answer is growth, not inflation. US inflation-protected bond yields have risen along with the nominal yields of other bonds. That tells us that higher growth will suck liquidity out of the global system just as a fast-growing firm will employ more cash in the business rather than invest in financial assets.
Tips (Treasury inflation-protected securities) yields have another message for us. The difference between the yields of similar-maturity US Tips yields and those of Treasuries is a measure of market expectations of inflation.