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

Interest rates are expected to continue their upward trend, but for now they are not expected to be high enough to harpoon the stock market.

Treasury yields have risen rapidly over the past week, and the 10-year benchmark yield has fallen – to 1.33% in the early hours of Wednesday morning before retreating below 1.30%.

Yields are moving at opposite prices, and the 10-year period rose from about 1.15% just a week ago to levels close to where they were when the pandemic began to hit the economy in February last year.

The 10 years are essential for the economy because they affect mortgages and other consumer and business loans.

Bond strategists say the yield movement has opened the door for a larger move, and the next logical target for the 10 years is 1.5%. Yields are unlikely to rise much further in the short term unless inflation rises or there is a signal from the Fed that it is ready to tighten policy, which is highly unlikely.

“I think it reflects economic conditions, which is why other financial assets, such as equities, are not doing too badly,” said Jim Caron, head of global macro strategy at Morgan Stanley Investment Management.

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

The Treasury Market set prices in a more aggressive fiscal stimulus program from the Biden administration than many analysts had initially expected.

The proposed $ 1.9 trillion package going through Congress cannot be greatly reduced. The package includes a payment of $ 1,400 to individuals, in addition to the $ 600 they received in early January.

In addition to the employment report, the recent data series showed an improvement.

January retail sales, reported on Wednesday, rose 5.3% from 1.2% and a drop in December.

Also, the producer price index rose sharply, up 1.3%, the most since 2009 in January, as the cost of goods and services rose. This suggests that inflation is starting to rise for producers and may be a warning for 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 personal consumption spending from year to year, the Fed’s preferred measure of inflation.

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

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

Even with better data, Wednesday’s 10-year yield traded at about 1.29% after peaking early in the morning. Strategists said buyers were attracted by around 1.30%, and the 10-year move could slow or strengthen before another step.

Strong data have prompted economists to raise their views on growth.

Goldman Sachs economists raised their tracking estimates for gross domestic product growth in the first quarter to 6% from 5%, and Morgan Stanley economists raised their tracking forecast to 7.5%.

“Stimulus checks are approaching, jobs are returning. We believe all of this will happen as the Covid number begins to decline,” Caron of Morgan Stanley said.

“We’re still going to get that $ 1,400 check,” he said. “In addition, there is a retained request. The party is just beginning.”

The return to the economy makes some investors worried that another large stimulus package will ignite inflation and leave the US struggling under a mountain of debt.

But Caron doesn’t believe the market is responding to this, and the stimulus is a necessary shake-up to fill the production gap created when the economy fell off a cliff last spring. He also does not expect inflation to be a problem.

However, the market is starting to appreciate with higher inflation. The 5-year balance sheet, a market-based inflation instrument, on Wednesday reflected the view that consumer inflation will average 2.37% over the next five years.

“You can choose if it is [the yield] growth with the stimulus or the economy and now the stimulus actually has an impact on the economy. We already have incentives that make people spend and incentives to come, that will stimulate more spending, “said Michael Schumacher, head of pricing strategy at Wells Fargo Securities.” Inflation has been a topic of discussion for the past few weeks. “

Economists expect inflation to rise in the spring, along with higher prices from accumulated demand. However, they do not expect growth to be strong enough for the Fed to engage in policy.

Ed Hyman, president of Evercore ISI, said on Wednesday that growth in 2022 seems stronger and above trend, due to the stimulus.

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

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

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

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

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

“The spending legislation in December has given the economy more fiscal support, as has the new Biden administration’s launch of its economic recovery proposals, which has sparked wider discussion of the outlook in the minutes, but President [Jerome] Powell’s press conference made it clear that the economy has not yet come out of the woods, “said Bob Miller, head of America’s fundamental fixed income at BlackRock.

“And the subsequent comments from other participants at the FOMC meeting reflect the now unified communications; in essence, ‘it’s too early to talk about reducing’ asset acquisitions, ‘” Miller said.