The sharp rise in long-term rates has been a major market feature of 2021, reflecting brighter prospects for the U.S. economy.
Gina Ferazzi/Los Angeles Times/Getty Images
Will good news for American workers again be bad news for stocks and bonds?
Friday’s blowout employment report, showing a huge 916,000 jump in nonfarm payrolls in March, threatens to reintroduce a softer version of the market leitmotif from the 1980s and 1990s, when weak indicators were greeted bullishly by the debt and equity markets, and strong ones weren’t. Signs of weakness implied easier monetary policy from the Federal Reserve, a boon to bonds and stocks.
Current central bank officials, from Fed Chairman Jerome Powell on down, have taken pains to insist that this is no longer the case. Current ultraeasy policies—pegging the federal-funds rate target at 0% to 0.25%, plus $120 billion in monthly bond purchases—are to continue until the labor market reaches “maximum employment” and inflation runs “moderately above 2% for some time,” according to last month’s policy statement by the Federal Open Market Committee. The FOMC members’ consensus view was that the fed-funds target would remain near zero through 2023.
But the Treasury and interest-rate futures markets cast increased doubt on the Fed’s intentions after the strong jobs numbers, which also showed that the headline unemployment rate fell to 6.0% from 6.2% in February. (While the equity markets were closed for Good Friday, the rates markets were open in the morning and reacted to the data.) Eurodollar futures were pricing in four 25-basis-point rate hikes by the end of 2023. (A basis point is 1/100th of a percentage point.)
In the Treasury market, the reaction was strongest in the “belly” of the yield curve, which reflects expectations in the medium term. The five-year note’s yield jumped a sharp 7.5 basis points, to 0.975%, the highest since Feb. 28, 2020, shortly before the Covid-19 lockdowns began. The reaction further out on the yield curve, however, was less stark, with the 10-year Treasury up 4.4 basis points, to 1.72%, below the recent high of 1.77% touched earlier in the week.
The sharp rise in long-term rates has been a major market feature of 2021, reflecting brighter prospects for the U.S. economy. Now, even the Fed sees 2021 gross-domestic-product growth of 6.5%, and private economists’ forecasts are for 7% or more, which would be the highest rate of growth since 1984’s “Morning in America” 7.2%. Such boom-like numbers don’t jibe with negative real rates; the 10-year Treasury inflation-protected security is trading at minus 0.65%.
Higher real U.S. interest rates tend to boost the dollar, which could have negative market consequences. “History is littered with examples of rising U.S. rates and a stronger dollar leading to financial and economic troubles, according to Alpine Macro. Among them: the Mexican debt crisis, which started in late 1994; the emerging market debt crisis of 1997-98; and pressure on the markets of Turkey, Brazil, India, South Africa, and Indonesia during the taper tantrum in 2013. (Turkey’s lira is under pressure again.)
Will the Fed’s rate outlook effectively get marked to the market? The Alpine Macro strategists think it will be the other way around. They contend that markets haven’t adjusted to the central bank’s intention of staying easy until the economy reaches maximum employment and of looking past what it deems “transitory” rises in inflation, which are becoming more apparent from supply bottlenecks.
While the Fed intends to keep monetary policy easy, fiscal policy could be tightened significantly next year. While attention is centered on President Joe Biden’s $2 trillion-plus infrastructure plan, Strategas Securities’ Washington team, led by Dan Clifton, writes that the massive Covid-19 stimulus will be fading next year, resulting in a $2 trillion “fiscal drag.”
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More to the point, “investors need to begin pricing in higher corporate, capital gains, and dividend taxes,” the Strategas team warns in a research report. The Biden infrastructure plan calls for a hike in the corporate tax rate to 28% from 21%, although that’s just an opening proposal.
The S&P 500, perched at a record level going into the holiday weekend, faces market expectations of tighter monetary policy and the likelihood of tighter fiscal policy. So, Wall Street could face headwinds, rather than the tailwinds it has become accustomed to, from Washington in the year ahead.
Write to Randall W. Forsyth at [email protected]
