It was all about bond yields this week. A sell-off in U.S. government bonds ricocheted through the markets on Thursday, sending share prices lower. In the U.S. the yield on the 10-year briefly surpassed 1.6% on Thursday before closing the week out at 1.46%. The yield on the 5-year bond jumped an impressive 20bps.
Same story overseas. Australian bonds posted their worst month since 1994, with 10-year yields approaching 2%.
Yields are on the move as investors start to anticipate the economy returning to some semblance or normality this summer. Certainly, consumer incomes have been boosted by the December stimulus bill. As you can see below, consumer spending increased +2.4% in January while incomes surged +10%.
Expectations for first quarter GDP growth have shot up to almost 9%, at least according to the Atlanta Fed estimate.
This is feeding through into higher inflation expectations. A common measure of inflation expectations is shown below.
Now we probably shouldn’t get too carried away with the Weimar Germany inflation theme. Inflation expectations are simply back to where there were in 2013. And some well-regarded analysts thinks the spike in inflation expectations will prove temporary. For example, Dan Ivascyn, CIO at PIMCO, warned of an ‘inflation head fake’, where misplaced concerns about a rise in consumer prices cause a jump in bond yields. He argues that any inflation pick-up will prove temporary because of long-established trends such as technological innovation cutting costs and the weakness of organized labor. Slack will also linger in the labor market due to high unemployment. Specifically:
‘We still see powerful disinflationary trends. After an initial recovery [from the pandemic] there is likely a world of excess capacity…’
Certainly, the data hasn’t caught up with expectations yet. The Fed’s preferred measures of annual inflation is still well below their target of 2%, as you can see below.
All eyes will be focused on the upcoming stimulus bill making its way through Congress. Things may come to a head in a couple of weeks as the current expanded unemployment benefits run out March 14th. Democrats have said they want a bill passed by then. The House should vote today, then it is up to the Senate, which is using the arcane budget reconciliation process, to pass a bill by simply majority. Then the bill goes back to the house.
How Much is Too Much?
So the key question is how much is too much on the interest rate front? MRB took at stab at answering this:
‘There is always a great debate during cyclical economic expansions once bond yields start to climb as to when the increase in yields (and eventually the shift in monetary policy) moves from being reflective of better economic activity to becoming restrictive….The (likely answer) is that usually the gap between policy rates and underlying nominal GDP growth closes meaningfully and real yields increase significantly as equities enter a bear market. While year-on year nominal GDP growth is still currently depressed, it is set to spike after last year’s implosion, and is expected to settle at an historically solid rate. Real yields are close to multi-decade lows and are far from being restrictive for borrowers, especially if underlying inflation is flat-to-higher. Although we expect real yields to move higher over time, the pace is not likely to be threatening for the foreseeable future.’
The key point in the chart above is that monetary policy needs to get restrictive to trigger a sustained bear market in stocks. MRB thinks we are a number of quarters away from that. Time will tell.
Charts We Found Interesting
1. All the major COVID measures are down dramatically.
2. The trends in nursing home COVID cases and deaths is particularly noteworthy.
3. The bad news? The decline in cases appears to be leveling out. Are the new mutations gaining a foothold?
4. Mainland Europe isn’t exactly coving itself in glory in terms of vaccine rollout.
5. People in the U.S. are more willing to get vaccinated.
6. Strong support for the next stimulus plan.
7. Where have all the homes gone?
8. From The Economist: ‘Over the summer of 2020, as coronavirus cases fell and life in Britain felt briefly normal, something very abnormal was happening to the country’s electricity supply. No coal was burned to generate any portion of it for a period of more than two months, something that had not happened since 1882. Britain’s four remaining coal-burning power plants are zombies, all but dead. Within a couple of years they will be closed and Britain will probably never burn coal for electricity again.’
9. It looks like the U.S. is on the same path.
10. Why women live longer than men, reason 257 – the chart below shows a UVA study of students who were asked to sit alone in a room for 15 minutes next to a device that would administer an electrical shock. The chart shows the percent who decided to give themselves a painful shock.
Have a good weekend.
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