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

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

Treasury yields have risen rapidly over the past week and the 10-year benchmark yield has stagnated: it reached 1.33% early Wednesday morning before falling below 1.30 %.

Yields are moving against the price and the ten years have gone from about 1.15% just a week ago to levels close to what they were when the pandemic began to hit the economy last February.

Ten years is key to the economy as they affect mortgages and other consumer and business loans.

Bond strategists say the yield move has opened the door to a higher move and that the next logical target for the ten years is 1.5%. It is unlikely that yields will rise much more in the short term unless inflation recovers or there is a signal from the Fed that it is willing to tighten policy, which is highly unlikely.

“I think it reflects economic conditions, and that’s why other financial assets, like equities, don’t take it too badly,” said Jim Caron, head of global macro strategy at Morgan Stanley Investment Management.

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

The Treasury market has been setting prices on a more aggressive fiscal stimulus program from the Biden administration than many analysts had initially expected.

The proposed $ 1.9 trillion package opening in Congress cannot be greatly reduced. The package includes a $ 1,400 payment to individuals, in addition to the $ 600 they received in early January.

Aside from the job report, the recent data streak has improved.

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

The producer price index also rose sharply, by 1.3% more, from 2009 to January, as the cost of goods and services increased. This suggests that inflation is starting to rise for manufacturers and may be a warning for higher consumer prices.

JPMorgan economists estimate that the increase in the producer price index translates into a higher forecast of a 1.7% increase in personal consumption expenditure year-on-year, the preferred measure of inflation for the Fed.

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

“If this baseline PCE inflation forecast is made, it would be the strongest monthly increase since January 2007, keeping the previous year’s core PCE rate below the 2% inflation target of the FOMC, ”JPMorgan economists wrote in reference to the Federal Open Market Committee.

Even with the best data, Wednesday’s 10-year yield traded around 1.29% after the morning’s rise to highs. Strategists said buyers were attracted around 1.30%, and the ten-year move could now slow or consolidate before another step.

Strong data led economists to raise their views on growth.

Goldman Sachs economists raised their first-quarter gross domestic product growth estimate from 6% to 5%, and Morgan Stanley economists raised their forecast forecast to 7.5%.

“Stimulus checks are coming, jobs are coming back. We believe all of this will happen as Covid numbers start to decline,” Caron of Morgan Stanley said.

“We’re still going to get this $ 1,400 check,” he said. “Also, there is accumulated demand. The match is just beginning.”

The leap into the economy is causing some investors to worry that another big stimulus package is igniting inflation and leaving the U.S. struggling under a mountain of debt.

But Caron doesn’t believe the market is responding to that, and the stimulus is a necessary shock to fill the production gap created when the economy fell off a cliff last spring. Nor does he expect inflation to be a problem.

The market, however, is starting to trade with more inflation. The five-year balance sheet, a market-based inflation instrument, on Wednesday reflected the view that consumer inflation averages 2.37% over the next five years.

“You can choose if it is [the yield] go up with the stimulus or the economy and now the stimulus really affects the economy. We already have incentives that make people spend and incentives that will come that will stimulate more spending, “said Michael Schumacher, head of type strategy at Wells Fargo Securities.” Inflation has been a point of conversation in recent weeks. “

Economists expect inflation to widen in the spring, along with higher prices from accumulated demand. However, they do not expect the increase to be strong enough for the Fed to undertake policies.

Ed Hyman, president of Evercore ISI, said Wednesday that 2022 growth looks stronger and above trend, due to stimuli.

He said he now expected 3% growth in 2022, after 7.8% growth in 2021. Still, Hyman’s view of inflation is still quite tame. “The basic PCE deflator is likely to increase by 2.25% year-on-year in both 2021 and 2022, high but not significant,” he wrote.

Hyman expects the ten-year yield 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 say rates shouldn’t go up too much with the Fed’s low-rate policy and its bond-buying program.

On Wednesday, the Fed reaffirmed its concerns about the economy and its plans to stay on hold for the foreseeable future, in the minutes of its last meeting.

“December spending legislation assured the economy of more fiscal support, as well as the launch of the Biden administration of its economic recovery proposals, which encouraged broader discussion of the outlook in minutes, but the president [Jerome] Powell’s press conference made it clear that the economy is not yet out of the woods, “said Bob Miller, America’s key fixed income chief at BlackRock.

“And subsequent comments from other participants at the FOMC meeting reflect that communications are now unified; essentially, ‘it’s too early to talk about reducing’ purchases’ of assets,” Miller said.