Federal Reserve Chairman Jerome Powell testifies before the Senate Banking Committee hearing on the “Quarterly Report on the CARES Act to Congress” at the Capitol in Washington, December 1, 2020.
Susan Walsh | Pool | Reuters
Equity investors are desperately trying to interpret what an increase in bond yields means for the stock market.
Since 10 February, 10-year Treasury yields – which are not adjusted for inflation – have gone from 1.13% to 1.61%, an increase of 48 basis points, the highest level in a year. (A base point is equal to 0.01%)
Fear of inflation is causing investors to speculate that the Federal Reserve may have to change policy earlier than expected, reducing bond purchases or even raising rates at some point. That would be negative for stocks. On the last count, on Thursday, the Dow dropped 500 points.
Peter Tchir of Academy Securities says the recent increase in 10-year bond yields represents a perception of inflation, but not necessarily the reality: “The increase in 10-year bond yields does not reflect a real increase in inflation, reflects what investors anticipate will have increased inflation, “he told me.
Tchir notes that Federal Reserve Chairman Jerome Powell has been resisting the idea that over-the-top inflation is coming, noting in his testimony that broad signs of inflation were not present in the real world and that, if they did, some such increases would be “transitory”.
Who is right about inflation?
Bond investors are becoming concerned about the potential for inflation. Powell says to stop worrying about it. Who’s right
It depends on who you ask and what you’re looking at.
Do we see inflation in the real world? We do it with commodities: oil is approaching the highest level since 2018, for example, and copper is at an almost 10-year high.
But signs of consumer inflation, for example, have been silenced, with inflation at or below 2% for many years.
Bulls like Tchir insist that, in this case, the increase in bond yields is not negative for stocks: “This time, the increase in yields comes from economic growth, stimulus and infrastructure. All of this is good for stocks. so this climb doesn’t scare me much. “
He says that the rise in commodity prices can be easily absorbed and believes that much of that 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 that inflation will increase: “Since the summer of 2020, economists have systematically underestimated economic growth in a way never seen before. It seems like a real risk, the Fed will not be able to sound dovish for much longer and this transition could have wider credit spreads. “
Limit actions
The key to the game, insists Tchir, is whether Powell will be able to keep his weapons: “If the Fed remains committed to keeping short-term yields low, it will give people comfort, we will not have a ‘tantrum’, whose rates suddenly Powell told us that he is comfortable with inflation and that he will not react to short-term movements. I believe he will remain firm. “
There is another problem: since stock prices are so high, there is no room for error. Small changes in yields can make technology investors, in particular, make profits, under the assumption that this is the best that can happen.
Veteran stock commentator Michael Farr of Farr, Miller & Washington has already told customers that even this relatively modest rate hike is a sign: “The days of simply joining market leaders, regardless of the valuation, may be coming to an Investors must now recognize that alternative opportunities exist, including hitherto underperforming stocks, as well as increasingly attractive bonds. A powerful economic recovery combined with rising interest rates and higher inflation, if it does, will change. the investment scenario in a meaningful way. “