Go big or go home, as the saying goes in America. However, after a year of remaining at home, investors are concerned about losing money or being caught off guard in their investments if the US government overshoots in its economic stimulus and generates an inflation hangover.
The strong, seven-week rise in benchmark government bond yields, with the 10-year Treasury TMUBMUSD10Y, 1.726 percent rate at 1.729 percent on Friday, up from a low of 0.51 percent a year ago, is one explanation for the dread. About financial markets, Joe Ramos, head of U.S. fixed income at Lazard Asset Management, stated, “There are some rules of thumb.” “The first is that rising rates are bad.” Companies will pass on higher borrowing costs to consumers by raising prices on goods and services, causing people to spend more yet get less bang for their buck, according to the theory. Any spending cutbacks could damage the recovering economy, even before it completely recovers from the coronavirus pandemic’s lockdowns. However, Ramos believes that several traditional financial market regulations have outlived their usefulness and should be discarded, particularly after yields in the $21 trillion US government Treasury market fell to new lows last year. According to Ramos, U.S. Treasurys have historically been a solid asset class for institutional investors seeking deflation protection, but he also described last year’s low Treasury yields as a “sign of sickness,” when it “appeared like the world was about to fall apart on us.” According to Ramos, rising yields in today’s environment are a result of more Americans getting vaccinated and an increase in Google searches for Disney DIS, -0.59 percent vacations, both of which are evidence of a recovering economy. “One thing I tell people is that even though it will cost more, they will be able to pay more,” he said. Patience, Powell This plan is contingent on the United States’ ability to recoup the 9.5 million jobs lost during the pandemic. In an op-ed published Friday, Federal Reserve Chairman Jerome Powell stated that he intends to support the US economy “for as long as it takes,” but added that the prognosis has improved. Powell emphasized the importance of the central bank’s unprecedented measures to stabilize financial markets despite the upheaval that erupted a year ago, using COVID-19 cases as an example. After a year, the United States has surpassed Europe and other parts of the world in terms of vaccines, leaving Wall Street guessing about what will happen next. “The larger picture is that it matters why rates are rising,” said Daniel Ahn, BNP Paribas’ senior US economist. “It’s not just about the numbers; it’s about the realities, and the Fed has been sounding very upbeat about these swings higher, thanks to the better economic outlook.” Despite the steep spike in long-term U.S. government yields over the past two months, credit spreads LQD, +0.15 percent, or the premium investors are paid above Treasuries to compensate for default risks on corporate debt, haven’t gapped out considerably, according to Ahn. Even if the technology-heavy Nasdaq Composite COMP, +0.76 percent has been under pressure, neither the US dollar DXY, -0.13 percent nor the Dow Jones Industrial Average DJIA, -0.71 percent nor the S&P 500 SPX, -0.06 percent have dipped into correction zone. On Friday, all three benchmarks saw weekly losses. Over the following two months, another 70 basis point increase in the benchmark 10-year US Treasury rate could be enough to spark broader market turbulence. “But we haven’t seen that yet,” Ahn remarked. Related: According to a strategist, there would be no rest until the 10-year Treasury yield reaches 2%. What? Credit Is Expensive It’s been 40 years since the prime lending rate in the United States hit 20%, when former Fed Chair Paul Volcker fought a long war against out-of-control inflation. Since then, generations of American homeowners have been able to secure 5-percentage-point 30-year fixed-rate mortgages, which are currently closer to 3-percentage-point rates. “Obviously, what inflation means for savers and Main Street differs from what inflation means for Wall Street,” said Nela Richardson, ADP’s chief economist, noting that people nevertheless bought houses and took out mortgages when mortgage rates were as high as 18 percent in the 1980s. “Bond investors are more confident in an economy that demands higher yields to retain relatively secure assets,” Richardson said, but he warned that higher yields might cause markets to get anxious if they indicate “the end of cheap money and almost free credit.” Trillions of dollars in pandemic fiscal stimulus from Congress might put inflation predictions to the test, just as more U.S. vaccines could contribute to a larger reopening of businesses this summer. “I think market investors are anxious since we haven’t seen inflation since Volcker,” said Brian Kloss, global credit portfolio manager at Brandywine Global. In an inflationary environment, Kloss said, “basic industries, commodities, and corporations with pricing power” should do well for shareholders, but he cautioned that the US will have more signals about the status of the COVID-19 threat in the coming weeks, following spring break gatherings. If the United States can prevent a spike in new coronavirus infections, unlike Europe, where additional lockdowns are still a possibility, it “may be one of the first signals of a vigorous summer, leading into fall,” he added. Meanwhile, according to Robert Tipp, PGIM Fixed Income’s senior investment strategist, the bond market appears to have already embraced the Fed’s determination to maintain monetary policy accommodative for some time. He cited recent highs in Treasury break-even rates as a hint that the bond market expects inflation to rise from emergency levels, based on break-evens, which are a predictor of future price pressures based on trading levels of U.S. Treasury inflation-protected securities (TIPS). Even if 10-year rates return to 3% and inflation rises in tandem with the Fed’s revised 6.9% GDP growth prediction for this year, Tripp expects both to return to the lower levels seen over the previous four decades. People predicted “inflation Armageddon” after the global financial crisis of 2008, and that the “Fed would never be able to get out of that policy” of quantitative easing, he claimed. Tipp replied, “Of course they did.” A slew of economic data from the United States will be released next week. Existing and new home sales for February will be released on Monday and Tuesday. Durable goods orders for February will be released on Wednesday, along with preliminary March manufacturing and services sector index revisions. On Thursday, the latest data on personal incomes, consumer spending, core inflation for February, and the latest consumer sentiment index reading will be released, as well as the final estimate of fourth-quarter GDP. On Friday, the latest data on personal incomes, consumer spending, core inflation for February, and the latest consumer sentiment index reading will be released.
Continue reading
