The strong economic recovery in the U.S. has led to corporate earnings growth well above expectations. As a result, equity markets recorded another very strong quarter. Interest rates also defied expectations by falling despite headline inflation news. The yield on the 10-year U.S. Treasury note fell to 1.4%, down from 1.7% at the end of March.
The reopening of the economy, pent up demand, continued low interest rates and government stimulus drove very strong economic growth in the U.S. Growth is expected to remain well above historical trend levels for several more quarters. Shortages of some goods due to supply chain disruptions are impacting a number of industries. Labor market improvement remains uneven and the impact of winding down of stimulus payments is hard to assess at this time. Passage of an additional infrastructure spending bill this year would add to the massive stimulus spending. One concern is the recent run-up in the price of oil as higher gas prices may offset some of the increase in consumer spending. The rest of world has lagged the U.S. economy, but many countries are starting to catch up as improved vaccination rates allow reopening.
We expect inflation fears and headline numbers to continue to cause market volatility. It will be at least several quarters before it is clear whether this inflation spike is transitory as most Fed members and many economists believe. Much of the sharp increase in year-over-year inflation this quarter can be attributed to one-time items and comparisons to price levels a year ago during the shutdown. Gradual improvement in supply chains and labor market gains would reduce some of the upward pressure on inflation. The decline in Treasury yields seems to indicate that the markets are in agreement with the Fed that the inflation spike is not likely to persist beyond the short-term.
Equity markets continue to benefit from the tailwind provided by very accommodative fiscal and monetary policy. Continued strong earnings growth is already priced into equity valuations, so any slowing of the rate of growth later this year may impact markets. Increased uncertainty related to future tax policy and regulation may also contribute to volatility in the second half of the year. We will be closely watching data over the next several months to get a better read on the outlook for inflation.