Interest rates will continue to rise, but do not blame everything on inflation, say economists

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

Treasury yields have risen sharply over the past week, and the standard yield for ten years was in tears, reaching 1.33% in the early hours of Wednesday before falling below 1.30%.

Yields are moving opposite price, and the decade rose from about 1.15% just a week ago to levels close to when the pandemic hit the economy last February.

The ten years are the key to the economy as it affects mortgage lending and other consumer and business lending.

Securities strategists say the shift in returns has opened the door for higher movement, and a next logical target for the ten years is 1.5%. The yield is unlikely to be much higher in the short term if inflation does not increase, or if there is a signal from the Fed that it is ready to tighten policy, which is highly unlikely.

“I think it reflects the economic conditions, so other financial assets, such as equities, do not take it too badly,” said Jim Caron, head of Morgan Stanley Investment Management’s global macro strategy.

“The thing is, you have not seen anything yet,” he said. “It’s with a $ 600 stimulus test. What about a $ 1,400 stimulus check in hand?”

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

The proposed $ 1.9 billion package that winds through Congress may not diminish much. The package includes a payment of $ 1400 to individuals, in addition to the $ 600 they received in early January.

Apart from the work report, the number of recent data has improved.

Retail sales in January, reported on Wednesday, rose 5.3%, compared with forecasts of 1.2% and after a decline in December.

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

JPMorgan economists estimate that the rise in the producer price index is a larger forecast of a 1.7% increase in annual personal spending, the Fed’s preferred inflation measure.

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

“If this forecast for core PCE inflation comes true, it will be the strongest monthly increase since January 2007, while keeping the core PCE rate from a year ago below the FOMC’s inflation target of 2%,” the JPMorgan economists wrote and referred to the Federal Open Market. Committee.

Even with the better data, the 10-year yield traded at around 1.29% on Wednesday after moving to a high early in the morning. Strategists said buyers have engaged about 1.30%, and the ten-year move could now slow down or consolidate before being raised again.

The strong data caused economists to raise their views on growth.

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

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

“We’re still going to get that $ 1400 check,” he said. ‘On top of that, there’s a pent-up question. The party is just beginning. ‘

Some investors are worried that a new large stimulus package will inflate inflation and leave the US under a mountain of debt.

But Caron does not think the market is responding to that, and the stimulus is a stir needed to fill the output gap that arose 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 price more inflation. The 5-year break-even, a market-based inflation instrument, reflects the view that consumer inflation will average 2.37% over the next five years.

‘You can choose whether it is now [the yield] go up with the stimulus or the economy and now the stimulus actually affects the economy. We have already done stimulus that makes people spend, and stimulus that comes, that will encourage more spending, “said Michael Schumacher, head of rate strategy at Wells Fargo Securities. Inflation has been a topic of discussion for the last few weeks. “

Economists expect inflation to rise in the spring, coupled with higher prices due to pent-up demand. However, they do not expect the increase to be sharp enough for the Fed to enter policy.

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

He said he now expects 3% growth in 2022, after 7.8% growth in 2021. However, Hyman’s view of inflation is still fairly tame. “The nuclear PCE deflator is likely to increase by 2.25% y / y in 2021 and 2022, increase but not significantly,” he wrote.

Hyman expects the return for ten years 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 believe that rates should not rise too much with the Fed’s low interest rate policy and its bond buying program.

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

“The spending legislation of December secured the economy more fiscal support, as well as the incoming Biden government’s announcement of its economic recovery proposals, which clarified the broader discussion of the outlook in the minutes, but chairman [Jerome] Powell’s press conference made it clear that the economy is not out of the woods yet, “said Bob Miller, head of US fundamental fixed income at BlackRock.

“And subsequent comments from other participants in the FOMC meeting reflect the now united communication; mainly that ‘it is too early to talk about reducing asset purchases,'” Miller said.