What has the markets rattled this time? So far in 2021, we have seen bond yields moving higher.
At one point last year (in April 2020), the yield on the 10 year Treasury was 0.57%.
At the time of this writing (March 2021) the yield is now 1.55%. When interest rates rise, bond values fall.
But here’s an interesting point which many seem to overlook:
The yield on the same investment in January 2020 was 1.82%.
In February 2020 the yield on the ten-year Treasury was 1.55%.
Then we had the “fifteen days to flatten the curve” which has lasted 349 days (so far).
And here we are, back at 1.55% on a ten-year yield. Right where we stood, thirteen months later.
So why would a “round trip” in rates have markets rattled now? As mentioned in the previous post a few weeks ago, we continue to live in interesting times.
What has changed to get markets rattled?
A lot of folks want to focus on the changes in Washington, a new administration, changes in control in Congress, etc. And while that may have some impact, it is likely less than most people fear.
The far bigger story is with the Federal Reserve and interest rates. We’ve spent weeks and months trying to get folks to focus on what the Fed is doing, rather than see them base their sleepless nights (and investment decisions) on the number of seats the blue team or the red team holds in the Senate.
Don’t lose sight of the bigger story: the Fed.
Unlike at the end of 2019 and into the start of 2020, the Federal Reserve has been extremely accommodative, bringing massive liquidity into the financial system. In my opinion, Chairman Powell and the Federal Reserve acted appropriately last spring. They moved quickly and they moved decisively.
And the Fed moved with a size we have never seen before.
It’s this last point I believe a lot of people have seemed to have overlooked. The size of the Fed moves last spring will drive our economy and the markets for years.
Yes, years.
In the wake of the financial markets meltdown after 2008, the Federal Reserve brought rates to zero and began several rounds of quantitative easing. What the Fed unleashed last spring are multiples more than what markets absorbed in 2008.
A massive injection of liquidity into the system could, by textbook definition, bring inflation. This worries some market participants. And economics professors. But the Federal Reserve leaders, including Chairman jay Powell, and even previous chair Janet Yellen (now Secretary of the Treasury), have done splendid work landing the jet on the tarmac.
The Fed has stated on several occasions they will wait for the economy to reach nearly full employment before raising rates. This has some market “experts” concerned because it could take quite a long time to recover the jobs lost in the shutdown.
The economy was beginning to reach this “full employment” range (an unemployment rate somewhere below four percent). Today, there are still 10-12 million still out of work in early 2021. The U-6 unemployment rate stands at more than 11%.
On Friday March 5, 2021 the February employment report showed a healthy increase of 379,000 jobs added. The economy is only just getting re-started.
But this makes some bond market participants uncomfortable. Their textbooks/playbooks tell them that increasing jobs, increasing earnings, accelerated growth will bring inflation. And inflation is terrible for bond investments.
However, the Fed is NOT uncomfortable. Powell and the Fed governors have been steadfast in their message that while we MAY see a rise in inflation at some point, it will be a temporary short term rise in inflation. But a temporary rise in inflation is very different from “sustained inflation” like we witnessed in the late 1960’s until the early 1980’s. We discussed this in a recent video.
As bond traders expect rates to rise (rates have been rising quickly), the recent popular trade over the last few weeks has been to short Treasuries. This means selling treasuries, and as they fall in value, buying them back at lower prices.
This volatility in bond yields spills over to the stock market. Part of that stems from short-covering trades on the bond portfolios. The money to cover the short positions needs to come from somewhere.
These gyrations in the bond market also lead to stock market reallocations as well. In periods of low (or falling) rates, growth-oriented areas – like technology – do extremely well. We saw this in 2020. However, as rates rise, these heavy-growth-related stories become less attractive.
We then see money “rotate” into other sectors of the markets. This is precisely what has been happening these past few weeks.
Does it mean technology is suddenly a bad investment? No.
As Powell and the Fed continue to maintain their stance regarding inflation and interest rates, bond market participants are essentially “voting” whether they feel the Federal Reserve will be right or wrong. Will the Fed be “behind the curve?” This is the type of thing that gets markets rattled.
In this case, “behind the curve” implies allowing the economy to grow unrestrained and permit “too much inflation” to re-enter the equation.
The inflation rate for the past ten years has hovered between 1% and 2%. For several years, the Fed has targeted “in excess of two percent inflation” as the moving target point where they will begin to tighten or restrain the economy with rate hikes.
We have to take the Fed at their word.
Are you curious why I have the image of “Marcie Dahlgren-Frost” (played by the excellent actress Laurie Metcalf) from the movie “Uncle Buck” in this post?
Admittedly, it’s hard to find an image that successfully translates into “markets rattled.” But a phone caller this week asked, “well, what flew up the market’s nose THIS week?” which is a swipe from one of Marcie’s lines from Uncle Buck “well, what flew up HER nose?”