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

Flat rates are expected to continue their march up, but for now they are not expected to get high enough to accelerate the stock market.

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

Yields are moving against the price, and the 10-year has gone up from around 1.15% just a week ago to levels that are close to where they were when the pandemic began to hit. the economy in February last year.

The 10-year is critical to the economy, as it affects mortgages and consumer and other business lending.

Bond strategists say the move in yield has opened the door for a higher move, with 1.5% the next logical target for the 10-year period. Yields are unlikely to rise much in the short term unless inflation picks up or there is a signal from the Fed that it is ready to tighten policy, which is highly unbelievable.

“I think it reflects economic conditions, which is why other financial assets, such as equities, are not being taken too seriously,” said Jim Caron, head of global macro strategy at Morgan Stanley Investment Management. .

“The thing is you don’t see anything yet,” he said. “That’s with a $ 600 incentive study. What about with a $ 1,400 incentive study in hand?”

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

The proposed $ 1.9 trillion package that will go through Congress may not be significantly reduced. The package includes a $ 1,400 payment to individuals, in addition to the $ 600 they received in early January.

In addition to the jobs report, there has been significant improvement in recent data.

January sales, reported Wednesday, rose 5.3%, compared to a 1.2% forecast and after a decline in December.

The producer price index also rose sharply, up 1.3%, mostly from 2009 in January when the cost of goods and services jumped. That indicates that inflation is starting to rise for manufacturers and may be a forecast for higher consumer prices.

JPMorgan economists estimate that the rise in the producer price index translates into a higher forecast of a 1.7% increase in personal spending year-over-year, 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 is to be realized, it would be the strongest monthly increase since January 2007 while the PCE rate would be kept a year ago below the 2% FOMC inflation target,” JPMorgan economists wrote, referring to the Federal Open Market Committee.

Even with the better data, Wednesday’s 10-year yield traded at around 1.29% after an early morning move to highs. Strategists said buyers were dragged in at around 1.30%, and the 10-year move could now slow or consolidate before another step goes up.

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

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

“Motivation studies are coming, jobs are coming back. We think this is going to happen as Covid ‘s numbers start to fall,” said Caron of Morgan Stanley.

“We’re still going to get that $ 1,400 review,” he said. “Plus, there’s a huge demand. The party is just getting started.”

By jumping into the economy some investors are worried that another major stimulus package will inflate inflation and leave the U.S. struggling under a mountain of debt.

But Caron does not think the market is responding to that, and the stimulus is a voltage needed to close the output gap created when the economy collapsed last spring. . Inflation is also not expected to be a problem.

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

“You can make the choice whether it is [the yield] going up with the stimulus or the economy and now the stimulus is really affecting the economy. We have already made a stimulus that will drive people to spend, and an incentive to come that will drive more costs, “said Michael Schumacher, head of rate strategy at Wells Fargo Securities.” Inflation has been a a place to talk for the last few weeks. “

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

Ed Hyman, chairman of Evercore ISI, said Wednesday that 2022 growth looks stronger and higher than the move, due to stimulus.

He said he now expects 3% growth in 2022, after a 7.8% growth in 2021. However, Hyman’s view on inflation remains quite tame. “The core PCE deflator is likely to increase by 2.25% y / y in both 2021 and 2022, elevated but not significantly,” he wrote.

Hyman expects the 10-year yield to reach 2% this year and 2.5% next year.

“Perhaps the most important point here is that we are at an early stage of a new expansion that is likely to last at least through 2025,” he wrote in a note.

Strategists say rates should not rise too much with the Fed’s low-level policy and bond-buying program.

The Fed on Wednesday reiterated its concerns about the economy and its plans to halt it in the future, in the minutes of its last meeting.

“The December spending legislation provided the economy with more fiscal support, as did the Biden administration in its economic recovery proposals, which clarified the wider debate on 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 BlackRock’ s core U.S. basic income.

“And subsequent comments from other FOMC meeting partners indicate that communication is now unified; in fact ‘it is too early to talk about’ tapering ‘the purchase of assets,” Miller said.