Federal Reserve Chairman Jerome Powell testifies before the Senate Banking Committee hearing on the “Quarterly Report of the CARES Act to Congress” on Capitol Hill in Washington on December 1, 2020.
Susan Walsh | Swimming pool | Reuters
Stock investors are desperately trying to interpret what it means to increase bond yields for the stock market.
As of February 10, 10-year Treasury yields – which are not adjusted for inflation – have risen from 1.13% to 1.61%, an increase of 48 basis points, the highest level in a year. (One basis point is 0.01%)
Fear of inflation leads investors to speculate that the Federal Reserve may have to change policy sooner than expected, either by reducing bond purchases or even by raising rates at some point. This would be a negative for stocks. On the last day, Thursday, the Dow fell 500 points.
Peter Tchir of Academy Securities says the recent rise in 10-year bond yields is a perception of inflation, but not necessarily the reality: “The rise in 10-year bond yields does not reflect real inflation, reflects the fact that investors anticipate it will be a rising inflation, “he told me.
Tchir notes that Federal Reserve Chairman Jerome Powell has pushed back against the idea of overburdening inflation, noting in his testimony that large signs of inflation have not been present in the real world and that if they do, such increases would be ” transients ”.
Who is right about inflation?
Bond investors are worried about the potential for inflation. Powell says stop worrying. Who is right?
It depends on who you ask and what you look at.
Do we see inflation in the real world? We do it in raw materials: oil is closest to 2018, for example, and copper is at a maximum level of almost 10 years.
But the signs of consumer inflation, for example, have been turned off, with inflation at or below 2% for many years.
Bulls as Tchir insists that the increase in bond yields in this case is not negative for equities: “This time the increase in yields comes from economic growth, stimulus and infrastructure. All of this is good for equities. That’s why this increase doesn’t scare me. too much “.
He says that the rise in commodity prices can be easily absorbed and considers that much of this increase is only a temporary condition that reflects the reopening and that prices will return to “normal” levels over time.
Hans Mikkelsen, a credit strategist at Bank of America, is not so sure. He agrees with Tchir on economic growth, but believes it will be much stronger than expected and this will push inflation up: “Since the summer of 2020, economists have consistently underestimated economic growth to an extent that it has never been seen before. There is a real risk the Fed will not be able to ring any longer and this transition could see larger credit spreads. “
Stocks on the edge
The key to the game, Tchir insists, is whether Powell can stick to his weapons: “If the Fed remains committed to keeping short-term yields low, this will give people comfort. occur suddenly. Powell told us he was comfortable with inflation and would not react to short-term moves. I think he’ll stick to his weapons. “
There is another problem: because stock prices are so high, there is no room for error. Small changes in yields could lead technology investors in particular to take profits, assuming that this is as good as it gets.
Veteran stock commentator Michael Farr of Farr, Miller and Washington has already told clients that even this relatively modest rate hike is a signal: “The days when market leaders are simply crowded, regardless of valuation, are they can come to an end. Investors must now recognize that there are alternative opportunities, including both underperforming stocks to date and increasingly attractive bonds. A strong economic recovery combined with rising interest rates and higher inflation, if it does happen, will change the investment environment significantly. “