One of the more remarkable anomalies in a year full of them was the persistent disconnect in 2022 between benchmark US yields and inflation outcomes.

Long story short, yields should’ve been higher. And they still should be, based on their historical relationship with the 12-month rate of headline price growth.

The scatterplot below is very simple. In the era of experimental monetary accommodation, assessing fair value for bonds was anything but. Inflation was very low, so yields were too, but that’s where the normality stopped. Eyeballing yield levels was the furthest thing from straightforward post-GFC. For over a decade, G10 bonds and fixed-income markets more generally were a funhouse mirror, replete with absurdities. At one point in August of 2019, for example, entire corporate curves went negative in Europe effectively granting the associated companies a license to mint “assets.” Around the same time, some euro high-yield debt sported negative yields, a state of affairs one bank dubbed an “unfortunate oxymoron.”

The global stock of negative-yielding bonds disappeared almost entirely last year amid surging inflation in the developed world and central banks’ efforts to corral it, but notwithstanding the notion that bonds are now cheap (at least relative to stocks), it’s fair to say 12 months isn’t enough time to unwind all the distortions created over 12 years.

Given all of that, I suppose it’s not entirely surprising that 10-year Treasury yields never managed to catch up to inflation this cycle. As Deutsche Bank’s Aleksandar Kocic suggested at one juncture, markets appear to have achieved at least partial independence from the macro fundamentals.

With long-end yields now prone to receding amid burgeoning recession fears and softer, but still elevated, inflation, it seems unlikely that the disconnect shown by the red squares in the figure will resolve.

Sure, inflation will probably fall such that next year’s squares are circles (i.e., points representing CPI and 10-year yield conjunctures will look more consistent with their historical relationship when plotted), but last year’s experience might’ve suggested that some of the distortions created by a dozen years of monetary largesse are permanent — that price discovery in some markets has been so impaired for so long, that the sensitivity of some assets to macro variables will never be what it was.

With all of that in mind, consider equity valuations’ relationship to inflation, in this case core PCE. The figure on the left below, from SocGen, suggests stocks are still trading too rich on a trailing multiple. There are around 21 crimson dots in the chart which, I assume, means the bank was highlighting the same stretch I did in the scatterplot above (i.e., from April of 2021, when inflation began to accelerate, through year-end 2022).

“With higher inflation came higher real rates and as a result, valuations came under significant pressure throughout 2022 [and] we believe core inflation has peaked in the US, so perhaps valuations can get some respite in 2023,” SocGen’s Vincent Cassot and Jitesh Kumar wrote, before cautioning that “valuation levels are still higher than average inflation levels would justify [so] it is possible that the valuation adjustment continues.”

The figure on the right suggests a lingering disparity between the S&P’s forward multiple and rates vol. “While the peak of rates volatility may be behind us, the current levels of equity valuations are still higher” than the historical relationship would suggest, Cassot and Kumar went on to say.

I don’t have any answers for most of the questions implicit in the above other than to state the obvious: If yields didn’t rise “enough” given inflation realities, then equity multiples may not have contracted enough, and if rates vol stays elevated, stocks may be trading too rich to earnings estimates which, by most indications, are themselves too optimistic.

Finally, I’d reiterate that these disparities can resolve as inflation recedes, but that won’t address the prolonged failure of both yields and equity multiples to respond to the surge in price growth consistent with their historical relationships.