No “conundrum” in bond/equity divergence

The maintenance of historically low levels of short-dated bond yields alongside the strong rally in the equity market has prompted much talk of a “bond-equity conundrum”, in which the two markets appear to be anticipating vastly different outcomes for the economy. But we think that this apparently contradictory behaviour is fully justified by the extraordinary circumstances of an improved economic outlook and diminishing risk aversion against a backdrop of enormous amounts of spare capacity and downside risks to inflation.