Interest rates will continue to rise, but don’t blame inflation on everything, economists say

Interest rates are expected to continue their march, but for now they won’t get high enough to harpoon the stock market.

Treasury yields have risen rapidly over the past week and the benchmark’s 10-year yield has been on a crack – to 1.33% on Wednesday in the early morning hours, before falling below 1.30%.

Yields are moving opposite to price, and the 10-year is up from about 1.15% a week ago to levels close to where they were when the pandemic started hitting the economy last February.

The 10th anniversary is key to the economy as it affects mortgages and other consumer and business loans.

Federal strategists say the movement in interest rates has opened the door for a higher rate, and the next logical target for the 10-year-old is 1.5%. It is unlikely that interest rates will get much higher in the near term unless inflation picks up or there is a signal from the Fed that it is ready to tighten policy, which is highly unlikely.

“I think it reflects the economic conditions, so other financial assets, such as equities, are not taking too badly,” said Jim Caron, global macro strategy chief at Morgan Stanley Investment Management.

“The thing is, you haven’t seen anything yet,” he said. “That’s with a $ 600 incentive check. And a $ 1,400 incentive check in hand?”

The Treasury market has priced in a more aggressive fiscal stimulus program from the Biden government than many analysts initially expected.

The proposed $ 1.9 trillion package making its way through Congress may not be diminished much. The package includes a payment of $ 1,400 to individuals on top of the $ 600 they received in early January.

Aside from the jobs report, the set of recent data has improved.

January retail sales, reported Wednesday, were up 5.3% from forecasts of 1.2% and after a decline in December.

The producer price index also rose sharply, at 1.3%, its highest level since 2009 in January, when the cost of goods and services rose. That suggests that inflation is starting to rise for manufacturers and could be a warning of higher consumer prices.

JPMorgan economists estimate that the rise in the producer price index translates into a higher forecast of a 1.7% increase in annualized personal consumption spending, the Fed’s preferred inflation measure.

The so-called PCE measures changes in the cost of goods and services purchased by consumers.

“If this forecast for core PCE inflation is realized, it would be the strongest monthly increase since January 2007, while the core PCE rate would remain below the FOMC’s 2% inflation target a year ago,” the economists wrote. JPMorgan, referring to the Federal Open Market Commission.

Even with the better data, the 10-year return traded at about 1.29% Wednesday after the early morning move to its highest point. Strategists said buyers were attracting around 1.30%, and the 10-year move may now slow down or consolidate before another step up.

The strong figures prompted economists to put forward their vision of growth.

Goldman Sachs economists increased their tracking forecast for Q1 gross domestic product growth from 5% to 6%, and Morgan Stanley economists increased their tracking forecast to 7.5%.

“Stimulus controls are coming, jobs are coming back. We think this is all going to happen when Covid numbers start to fall,” said Morgan Stanley’s Caron.

“We still get that check for $ 1,400,” he said. Moreover, there is pent-up demand. The party has just begun. ‘

The start-up of the economy has worried some investors that another major stimulus package will fuel inflation and leave the US struggling with a mountain of debt.

But Caron doesn’t think the market will respond, and the stimulus is a shock needed to close the output gap created when the economy fell off a cliff last spring. He also doesn’t expect inflation to be a problem.

However, the market is starting to price in more inflation. The 5-year break-even, a market-based inflation tool, reflected Wednesday that consumer inflation will average 2.37% over the next five years.

“You can take your pick whether it is [the yield] goes with the stimulus or the economy and now the stimulus is actually affecting the economy. We already have an incentive that drives people to spend, and an incentive to come that will drive more spending, “said Michael Schumacher, director of pricing strategy at Wells Fargo Securities. Inflation has been a topic of discussion in recent weeks. “

Economists expect inflation to flare up in the spring, along with higher prices due to pent-up demand. However, they do not expect the rise to be strong enough for the Fed to pursue policy.

Ed Hyman, chairman of Evercore ISI, said on Wednesday that growth in 2022 looks stronger and above trend thanks to stimulus measures.

He said he now expects growth of 3% in 2022, after growth of 7.8% in 2021. Hyman’s view of inflation is still quite moderate, however. “The core PCE deflator is likely to increase 2.25% y / y in both 2021 and 2022, increased but not significantly,” he wrote.

Hyman expects 10-year yields to reach 2% this year and 2.5% next year.

“The most important point here is probably that we are in the early stages of a new expansion that will probably last at least until 2025,” he wrote in a note.

Streets say interest rates should not rise too much with the Fed’s low interest rate policy and bond buying program.

The Fed reaffirmed its concerns about the economy and its plans to put it on hold for the foreseeable future in the minutes of its last meeting on Wednesday.

December’s spending legislation assured the economy of more fiscal support, as did the forthcoming Biden government’s publication of its proposals for economic recovery, fueling broader discussion of the outlook in the minutes. [Jerome] Powell’s press conference made it clear that the economy is not out of the woods yet, ”said Bob Miller, head of US fundamental fixed income at BlackRock.

“And subsequent comments from other FOMC meeting attendees reflect those now unified communications; in essence, ‘it’s too early to talk about winding down’ asset purchases,” Miller said.