Markets stall as investors focus on inflation and interest rates
February 22, 2021
Equity markets have stalled following an impressive 20% return since November, as investors await progress on a stimulus deal and continued signs of an improving economy. As we pass the anniversary of last February’s market peak, the pace and strength of the bull run continues to impress observers. The S&P 500® Index has gained 75% from the March low, the best start to a bull market since the 1930s, per Bloomberg. This represents more than half of the median return from the 13 previous bull cycles at 126%. Money is increasingly being allocated to equities, with funds seeing a record $36 billion of inflows last week and hedge fund net leverage at a record. Corporate managements are also expressing optimism, with buyback announcements at a record high.
Rising interest rates are beginning to concern some investors, with the 10-year Treasury yield at the highest level in nearly a year at 1.37%. The yield curve continues to steepen on the combination of increasing optimism for global growth, shifts in inflation expectations and worries about the Fed tapering asset purchases, with the spread between the 10-year and 2-year Treasury yield at the widest level since 2017. Global yields are also trending higher, though there remains $14 trillion in negative yielding debt globally, down from December’s peak of $18 trillion. While historically low, rising interest rates would act as a headwind for corporate profits and valuations.
House Democrats are moving forward with a party-line vote on their $1.9 trillion stimulus plan through reconciliation to avoid a filibuster. Republicans continue to oppose the jump in the minimum wage to $15 per hour and $350 billion in aid to state and local governments. The Senate is planning to debate the legislation the following week so that a package can be signed before unemployment benefits expire on March 14. This would bring the total stimulus to nearly $6 trillion, or nearly 30% of GDP. President Biden plans to quickly move on to an infrastructure bill of more than $2 trillion, which would likely require revenue offsets through tax increases.
Covid-19 cases continue to plummet, with cases down 74% from the January peak to the lowest level since October, while hospitalizations are down 57%. A study conducted in Israel showed that the Pfizer/BioNTech vaccine was over 89% effective at preventing infections and 99% effective at preventing deaths. Also, new research shows that people that were previously infected showed a substantially higher response to a single dose of vaccine, potentially freeing up doses.
Fed chair Powell is scheduled to testify in front of Congress next Tuesday and Wednesday, with the Fed releasing their Monetary Policy Report in advance. The report notes that the improvement in the labor market has slowed, and that inflation remains below pre-outbreak levels. It adds that financial conditions have improved notably and remain generally accommodative and institutions at the core of the financial system remain resilient, though some financial vulnerabilities have increased since the start of the pandemic. Since the Fed began expressing the 2% inflation goal in 2012, the average growth has been 1.3%. Current inflation is near that level, though inflation expectations are well above 2%.
What to Watch
This week marks the end of February, with consumer confidence on Tuesday, new home sales on Wednesday, durable goods, pending home sales and revised fourth-quarter GDP on Thursday, and the PCE deflator, personal income and spending and consumer sentiment on Friday. Fed Chair Powell’s testimony to Congress will be watched for hints on the path of Fed policy.
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