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

Interest rates are expected to remain high, but for the time being they are not expected to rise enough to harpoon the stock market.

Treasury yields have been rising rapidly in the past week, and the 10-year benchmark yield is falling – reaching 1.33% in the early hours of Wednesday morning, before dropping below 1.30%.

Yields move in the opposite direction to price, and the 10-year rate rose from about 1.15% just a week ago to levels that are close to where they were when the pandemic started hitting the economy last February.

The 10-year term is critical to the economy, as it affects mortgages and other loans to consumers and businesses.

Bond strategists say the movement in yields has opened the door to a higher movement, and the next logical target for the 10-year term is 1.5%. Yield is unlikely to rise much more in the short term, unless inflation rises or there is a sign 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, like stocks, 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. “This is with a $ 600 stimulus check. How about a $ 1,400 stimulus check in hand?”

The Treasury market has been pricing a more aggressive fiscal stimulus program from the Biden government than many analysts initially expected.

The proposed $ 1.9 trillion package in Congress may not be much 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 jobs report, the sequence of recent data showed improvements.

January retail sales, released on Wednesday, rose 5.3%, compared to projections of 1.2% and after a fall in December.

The producer price index also rose sharply, 1.3%, the highest since 2009, in January, when the cost of goods and services increased. This suggests that inflation is starting to rise for manufacturers and could be a warning for higher consumer prices.

JPMorgan economists estimate that the increase in the producer price index translates into a higher forecast of a 1.7% increase in personal consumption expenditures year on year, the Fed’s preferred inflation measure.

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

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

Even with the best data, the 10-year yield on Wednesday was trading at around 1.29% after the morning bullish move. The strategists said that buyers were attracted by about 1.30%, and the 10-year change may now slow or consolidate before another step.

Solid data prompted economists to raise their views on growth.

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

“Stimulus checks are coming, jobs are coming back. We think all of this is going to happen when Covid’s numbers start to drop,” said Morgan Stanley’s Caron.

“We are still going to get that check for $ 1,400,” he said. “In addition, there is a pent-up demand. The party is just beginning.”

The boost to the economy has worried some investors that another big stimulus package will inflame inflation and leave the US struggling with a mountain of debt.

But Caron doesn’t think the market is responding to that, and the stimulus is a necessary shock to fill the output gap created when the economy fell off a cliff last spring. Nor does he expect inflation to be a problem.

The market, however, is starting to price more inflation. The 5-year breakeven point, a market-based inflation instrument, reflected Wednesday’s view that consumer inflation will average 2.37% over the next five years.

“You can choose whether it is [the yield] going up with the stimulus or the economy and now the stimulus is really impacting the economy. We have already carried out stimuli that are causing people to spend, and stimuli that will come will drive more spending, “said Michael Schumacher, head of rate strategy at Wells Fargo Securities.” Inflation has been a topic of debate in recent weeks. “

Economists expect inflation to rise in the spring, along with higher prices due to pent-up demand. However, they do not expect the increase to be strong enough for the Fed to become involved in politics.

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

He said he now expects growth of 3% in 2022, after growing 7.8% in 2021. However, Hyman’s view on inflation is still quite subdued. “The central PCE deflator is likely to increase 2.25% w / w in 2021 and 2022, high, 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 is likely to last at least until 2025,” he wrote in a note.

Strategists say rates are unlikely to rise much with the Fed’s low rate policy and bond-buying program.

On Wednesday, the Fed reaffirmed its concerns about the economy and its plans to be on hold in the near future, in the minutes of its last meeting.

“The December spending legislation guaranteed the economy more fiscal support, as well as the forthcoming Biden government’s announcement of its economic recovery proposals, which illuminated the broader discussion of the prospects in the minutes, but President [Jerome] Powell’s press conference made it clear that the economy is not yet in danger, “said Bob Miller, key fixed income director for the Americas at BlackRock.

“And subsequent comments from other participants at the FOMC meeting reflect that now unified communications; essentially, that ‘it is too early to talk about a gradual reduction’ in asset purchases,” said Miller.