February 21, 2022

Flatter Yield Curve = Profit Disappointment Ahead

The chart shows that yield curve flattening, proxied by the 10-year versus 2-year yield spread, has been driven by a divergence in short-term versus long-term expected inflation prospects, which creates the potential for corporate sector disappointment. In contrast with the divergence in expected inflation, real yields have had a parallel upward shift along the curve. The threat to equities stems from the fact that the Fed wants to jack up interest rates because of a short-term inflation scare, even though pricing power is limited by tame longer-term inflation expectations. Ergo, rosy consensus profit estimates are vulnerable to downgrades. For example, the Bloomberg 2022 consensus forecast for S&P500 EPS growth is 17%.