The market narrative hasn’t changed much over the last few weeks. It’s basically:
– The economy will reopen as spring turns into summer….
– …consumers are poised to spend, spend, spend…
– ….aided in no small part by the recently passed stimulus plan…
– …and a booming economy will ignite inflation and push interest rates up.
And traders have positioned for just such a scenario. As you can see below, the yield on the 10-year Treasury pushed above 1.7% this week.
What little economic data we’ve had recently is also confirming this. For example, the Philly Fed business outlook survey came in at 51.8, up 28.7 points. Economists thought it would print just 23.3 and no economist (out of more than three-dozen surveyed) predicted anything like the actual number. As it turns out, this latest report marks the highest number since 1973, the year the Oakland A’s took the World Series over the Mets in seven games. Yes, that’s a long time ago!
Money supply growth is also powering ahead, fueling the inflation/higher interest rate narrative.
But as we talked about last week, we probably should keep things in perspective. The latest increase in rates is basically on par with what we saw in 2012 and 2017, as you can see below.
Furthermore, not all rates have gone up. If you look Treasury rates across the curve you see a mixed picture.
At one point this week 1-month T-Bills traded with a negative yield, the first time since the crisis days last year.
This isn’t to downplay the pain investors have felt in longer-term bonds. As it turns out, the drawdown in the Bloomberg Barclay’s US Long Treasury Total Return Index (basically a measure of long-term bond price performance) is now at the largest level since 1998.
This probably should give anyone thinking about shorting bonds at this point some pause. The sentiment on bonds is also terrible – close to the lowest level in 34 years.
None of this means bond prices should rally (yields fall). But it does probably mean the bond bear market could go on hold for a while. It will be interesting to see how other asset classes react if this happens. Will the reopening trades like long value/commodities/financials take a pause and market leadership move somewhere else for a while?
The Fed’s Going Nowhere Anytime Soon
The Fed meetings over the last few months have been a snooze fest. They had nothing to say and market watchers really didn’t care what they said anyhow. This week’s meeting was a little different. With all the talk about rising inflation risks, the Fed’s view is now starting to matter.
So, did they say anything new on Wednesday? Decide for yourself:
1) The Fed’s projection of where rates will be in the coming years basically shows no rate hikes until 2023, as you can see below.
2) Chair Powell doesn’t think asset purchases will change anytime soon. Specifically, he said it was not yet time “to talk about talking about” tapering.
3) On inflation they did increases their outlook – the core inflation forecast for this year was revised up – though they think things subside next year. Powell stressed again that this year’s inflation developments should be viewed as transitory.
4) The Fed’s unemployment rate projection of 3.9% for 2022 is slightly below the “longer run” estimate of 4.0%. This suggests that the Fed believes the US will have reached full employment by the end of next year.
Not much new here. Really the only takeaway is that we are probably going to hear the word ‘transitory’ a lot in the coming months as it relates to inflation.
Now we should take everything the Fed says with a massive grain of salt. Michael Cembalest at JP Morgan made the following point this week:
‘The Fed’s decade of bad inflation forecasts: The chart below shows the Fed’s projections of future rates (grey lines) compared to what they actually ended up being. The Fed was basically wrong about growth and inflation for the better part of a decade, consistently overestimating the need for policy tightening.’
This isn’t to pick on the Fed specifically. Pretty much anyone making rate forecasts over the last few years has been way off (the notable exception is Lacy Hunt: https://hoisington.com/economic_overview.html). But is the Fed missing the mark again?
Well, yea, that’s probably a given. But in which direction? That is the multi-billion dollar question. Are they still overestimating how high rates will be in the coming years, or are we seeing a secular change where they will start underestimating inflation? No one really knows that answer yet, but it is probably the most important question in finance today.
Charts We Found Interesting
1. The U.S. is averaging well over 2mm vaccine shots per day now.
2. Conversely, the numbers out of Brazil are getting much worse.
3. Both the U.S. and U.K. might be able to get enough shots in arms before the Brazilian variant becomes ubiquitous. Europe could be in trouble on this score.
4. Another measure of how Europe differs from the U.S.
5. Is the labor market already getting tight? Small businesses are having trouble filling some jobs.
6. This chart is a little misleading because 2021’s number is annualized, but we are on track for a record year.
7. This might be a tough one to enforce.
Have a good weekend.
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