Federal Reserve Chairman Jerome Powell testified before the Senate Banking Committee hearing on “The CARES Bill’s Quarterly Report to Congress” at Capitol Hill in Washington on December 1, 2020.
Susan Walsh | Swimming pool | Reuters
Stock investors are desperately trying to interpret what a rise in bond yields means for the stock market.
Since February 10, ten-year Treasury yields (which are not adjusted for inflation) have risen from 1.13% to 1.61%, an increase of 48 basis points, the highest level of a year. (One basis point equals 0.01%)
Fear of inflation makes investors speculate that the Federal Reserve may have to change policy earlier than expected, either by reducing bond purchases or even raising rates at some point. That would be negative for the actions. Last Thursday, the Dow fell 500 points.
Peter Tchir, of the Securities Academy, says the recent rise in 10-year bond yields represents a perception of inflation, but not necessarily the reality: “The rise in 10-year bond yields does not reflect a real increase. of inflation, but it reflects that investors anticipate there will be an increase in inflation, ”he told me.
Tchir notes that Federal Reserve Chairman Jerome Powell has been backtracking on the idea that excessive inflation is being achieved, noting in his testimony that there have been no widespread signs of inflation in the real world and that if produce, these rises would be “transient.”
Who is right about inflation?
Bond investors are concerned about the potential for inflation. Powell says stop worrying about it. Who is right?
It depends on who you ask and what you are looking at.
Do we see inflation in the real world? We do it in commodities: oil is approaching its maximum since 2018, for example, and copper is reaching a maximum of almost ten years.
But the signs of consumer inflation, for example, have been silenced, with inflation below or below 2% for many years.
Bulls like Tchir insist that in this case, the rise in bond yields is not negative for stocks: “This time the rise in yields comes from economic growth, stimulus and infrastructure. All of this is good for to stocks. That’s why this climb doesn’t scare me too much. “
According to him, the rise in commodity prices can be easily absorbed and he believes that much of this rise is only a temporary condition that reflects the reopening and that prices will return to “normal” levels over time.
Hans Mikkelsen, a credit strategist at Bank of America, is not so sure. He agrees with Tchir on economic growth, but believes it will be much stronger than expected and this will drive inflation upwards: “Since the summer of 2020, economists have underestimated economic growth to an unprecedented point There is a real risk the Fed will not be able to look much longer and this transition could see wider credit differences. “
Stocks on the edge
The key to the game, Tchir insists, is whether Powell can stay in his arms: “If the Fed remains committed to keeping yields short-term, this will provide comfort to people, we won’t get any ‘taper rage.’ , where rates suddenly Powell has told us he feels comfortable with inflation and will not react to movements in the short term. I think he will stick to his weapons. “
There is another problem: because stock prices are so high, there is no room for error. Small changes in yields could cause technology investors, in particular, to make a profit, assuming this is as good as it gets.
Veteran stock commentator Michael Farr of Farr, Miller and Washington has already told clients that even this relatively modest rise in rates is a sign: “The days of simply accumulating market leaders, regardless of recognition, they may be running out.recognize that there are alternative opportunities, including actions with efficiency losses so far and increasingly attractive bonds.A strong economic rebound combined with rising interest rates and higher inflation , if this happens, it will change the context of the investment in a significant way. “