Rates Jump On Dovish Commentary From Fed
The bond market did not respond well to Fed Chairman Powell’s recent comments, especially when it came to letting inflation run hot. For those of us who follow the gyrations of the bond market daily, inflation has historically been the arch-enemy of bonds as higher inflation reduces the real return on bond investments. The idea of encouraging inflation to run hot and above the traditional 2% threshold is novel. Bond traders remain skeptical as the 10-year Treasury reaches levels last seen pre-pandemic. Bonds are also under pressure by the Fed’s announcement that the temporary change to the supplementary leverage ratio will run off at the end of March and also that banks will be required to lift reserve requirements. This news has added additional pressure on bond yields as banks are large holders of these instruments and now must sell them to raise capital.
Further muddying the waters is the threat of new lockdowns in Europe and India (which creates some uncertainty on the future path of the virus and could create havoc for all investable markets) as the virus surges in those areas and vaccinations have not been delivered in nearly the same capacity as in the U.S. Also, let’s not forget the increase in oil prices, lumber, oil, and commodities, all of which support the inflations argument, while the U.S. economy is improving. The Philly Fed Manufacturing Index also soared, which is yet another positive indicator that the economy is on the mend.
As we have written about previously, long-duration growth/tech equities are most at risk in a rising rate environment as are speculative investments, which are priced much higher based on a very low discount rate.
We are watching how equities and bond yields react as the pandemic becomes less of a problem. An unexpected housing boom was a welcome surprise during the pandemic year and was spurred on by a rise in equities paired with low-interest rates.
However, as rates move higher, monthly mortgage payments will increase, potentially cooling both purchases and refinances. Keep in mind that the 10-year Treasury is still well below 2% and that while we are off the bottoms, interest rates are still very low historically.
