Americans like to say go big, or go home.
But after a year of staying at home, investors are starting to worry they might lose money or be misled in their investments if the US government exceeds its support for the economy and causes an inflation hangover.
One reason for the collapse was the sharp seven-week rise in benchmark government bond yields, with the 10-year treasury TMUBMUSD10Y,
rate at 1.729% Friday, from a year ago low of 0.51%.
“There are certain rules of thumb,” said Joe Ramos, head of US fixed income at Lazard Asset Management, of financial markets. “One is that rising rates are bad.”
The idea is that if companies pay more to borrow, they will pass the rising costs on to consumers by pushing up prices for goods and services, causing households to spend more but get less value for their money. Any backlash by lenders could hurt the recovering economy, even before it fully reopens from the lockdowns imposed to combat the coronavirus pandemic.
But Ramos also believes some old financial market rules have reached maturity and should be retired, especially after US Treasury yields plummeted from $ 21 trillion to last year’s lows.
US Treasuries have long served as a reliable asset class for institutional investors seeking deflation protection, Ramos said, but he called what drove Treasury yields so low last year also a “ sign of illness ” while it “ seemed like the world was going to fall apart on us. ”
Rising revenues in today’s environment come as more Americans get vaccinated and Google searches for Disney DIS,
holidays are on the rise, signs of an economy returning to health, Ramos said. “One thing I tell people is that they will be able to afford more, even if it is going to cost more,” he said.
Powell Patience
This idea depends on the US’s ability to reclaim about 9.5 million jobs lost during the pandemic. Federal Reserve Chairman Jerome Powell said in an op-ed Friday that he plans to support the US economy “for as long as it takes,” but also said the outlook has gotten better.
Powell drew attention to the need for the central bank’s extraordinary steps to support financial markets amid the turmoil erupted a year ago by resolving COVID-19 cases. A year later, the US has advanced Europe and other parts of the world on vaccinations, leaving Wall Street looking for clues as to what comes next.
“The big picture is that it really matters why rates are rising,” said Daniel Ahn, US chief economist at BNP Paribas. “It’s not just the levels, but the facts behind them, and the Fed has sounded quite optimistic about these bullish moves, given the improving outlook for the economy.”
Ahn also pointed out that credit spreads LQD,
or the premium paid by investors over government bonds to offset the risk of corporate debt default has not materialized, despite the rapid rise in long-term US yields for about two months.
The US dollar DXY,
has not skyrocketed sharply either, as did the Dow Jones Industrial Average DJIA,
or S&P 500 SPX,
recessed in correction area, although the technology-heavy Nasdaq Composite COMP,
has been under pressure. All three benchmarks posted weekly losses on Friday.
Perhaps a further 70 basis point increase in the benchmark 10-year US Treasury yield over the next two months is enough to trigger broader market volatility. “But we haven’t seen that yet,” said Ahn.
Related: There will be no peace ‘until the interest on 10-year Treasury reaches 2%, says strategist
What? Expensive credit
Forty years have passed since the first US credit rate reached more than 20%, when former Fed Chairman Paul Volcker waged an enduring battle against runaway inflation.
Since then, generations of American homeowners have managed to raise 30-year fixed-rate mortgage rates to 5%, and they are now closer to 3%.
“It’s clear that what inflation means to savers and Main Street is different from Wall Street,” said Nela Richardson, ADP’s chief economist, adding that people were still buying homes and taking out home loans when mortgage rates were 18% in the 1980s.
“Bond investors are more confident in an economy that requires higher yields to hold relatively safe assets,” Richardson said, adding that markets tend to get jittery as higher yields end up being “the end of cheap money and virtually free. credit “mean.
Trillions of dollars of pandemic fiscal stimulus from Congress pouring through the economy, just as more US vaccinations may lead to wider corporate reopenings this summer, could challenge inflation expectations.
“Since we haven’t seen inflation since Volcker, I think market participants are concerned that this could unleash inflation,” said Brian Kloss, global credit portfolio manager at Brandywine Global.
Kloss said “basic industries, commodities and pricing companies” should do well for shareholders in an inflationary environment, but he also warned that in the coming weeks, following spring break meetings, the US will have more clues as to its status. the COVID-19 threat.
If the US can prevent a spike in new coronavirus cases, unlike Europe where further lockdowns remain a threat, “this could be one of the first signs of a robust summer heading into autumn,” he said.
Meanwhile, the bond market already appears to be a signal that it has embraced the Fed’s commitment to keep monetary policy flexible for the time to come, said Robert Tipp, PGIM Fixed Income’s chief investment strategist.
He pointed to Treasury break-even interest rates that recently moved above 2% as a signal that the bond market expects inflation to creep up from emergency levels, based on break-evens, an indicator of future price pressures based on of the trade levels of US Treasury inflation. protected securities (TIPS).
But even as 10-year yields rebound to 3% and inflation rises along with the Fed’s new 6.9% GDP growth forecast for this year, Tripp expects both to fall back to the lower levels seen over the past four decades. were known.
After the global financial crisis of 2008, people predicted “Armageddon inflation,” and that the “Fed could never get out of that policy of quantitative easing,” he said.
“Of course you do,” said Tipp.
Next week will be a deluge of US economic data. The sale of existing and new homes will be released Monday and Tuesday in February. Wednesday will bring February’s durable goods orders, as well as preliminary manufacturing and services index updates in March.
It’s weekly unemployment benefit data on Thursday and the final estimate of fourth-quarter GDP, while Friday will show the latest data on personal income, consumer spending, core inflation for February and the latest consumer sentiment indices.