Investors often have unique, sometimes even peculiar, ways of interpreting news. These days, it seems, good economic news is being translated into bad market news thanks to rising interest rates. The benchmark 10-year Treasury yield has spiked in recent months as investors see a brightening light at the end of the COVID-19 tunnel.
Strong employment gains last month helped perpetuate the yield rally. Employers added nearly 400,000 new jobs last month, exceeding most economists’ forecasts. An improving trend in COVID-19 cases and a relaxation of business restrictions also supported higher yields. More than 355,000 new leisure and hospitality jobs were added in February as bars and restaurants added staff, and the overall unemployment rate slipped 0.1 per cent to 6.2 per cent. Most economists expect the unemployment rate to fall in tandem with the COVID-19 infection rate. Treasury Secretary and former Fed Chair Janet Yellen told MSNBC earlier this week that she expects the labor market will reach full employment by 2022. While stimulus against a backdrop of reopening could spark higher prices, tight labor markets and the prospect of $15/hour national minimum wage represent the kindling needed to inflame sustainable inflation.
President Biden’s COVID-19 relief bill is another bit of good news keeping bond investors awake at night. The $1.9 trillion package passed the Senate Saturday night and is poised to become law this week. This bill would be the second-largest spending program in US history and includes $300 billion direct payments to households, $250 billion in unemployment insurance benefits, $117 billion to hospitals to support vaccine inoculations and $500 billion for loans, loan guarantees or other aid to businesses, states and municipalities. We expect cash to be hitting the streets at about the same time business restrictions will be lifted, and we believe this economic one-two punch will fuel a burst of spending and will drive up prices later this year.
Meanwhile, America is well on its way toward herd immunity. More than 2.2 million COVID-19 vaccines are administered daily, according to data from Johns Hopkins. At this rate, it will take an estimated six months for 75 per cent of the adult population to receive two doses of the vaccine. Currently, about 60 per cent of the population aged 65 and older have received at least one shot, including 70 per cent of those aged 75 and older. That’s good news for businesses hoping to attract in-person clientele. The Walt Disney Company reported today that its parks are now completely booked next week for Disney Resorts as well as theme park tickets. Disney’s Hollywood Studios also currently has no availability for guests for the rest of March.
These many pieces of good news are fitting together into a bright mosaic – and that’s got bond holders wringing their hands that today’s tepid interest rates could put them further behind inflation. Despite the Federal Reserve’s aggressive bond-buying program, bond investors have staged a buyers’ strike, pushing intermediate-term rates to levels not seen in a year. Higher interest rates, the discounting mechanism for determining “fair value,” are putting pressure on growth equities. The NASDAQ 100 slid nearly 10 per cent over the last four weeks as rates rose. Economically sensitive sectors, like energy and financials, are basking in the prospect of economic reopening. The S&P energy sector surged more than 34 per cent this year on the back of rising crude. Banks – institutions that benefit from a widening yield differential between short-term borrowing rates and longer-term lending rates – are more than 20 per cent higher this year.
Meanwhile, Jerome Powell’s Federal Reserve is content to sit back and let economic and market trends play out. The US central bank, in an effort to restock their inflation-fighting arsenal, have spent more than a decade beating the inflation beehive with a baseball bat with little to show for it. In fact, year-over-year inflation has not sustained above the Fed’s two per cent target rate since the 1990s. The Federal Open Market Committee, the Fed’s rate-setting group, is much more confident in their ability to tamp down overheating inflation than they are in their ability to fan inflation. After a decade of trying to boost price growth alone, monetary policymakers now have the check-writing power of the federal government behind their efforts. Remember, the Fed’s dual mandate is full employment and manageable inflation. It does not include propping up growth stocks.