The U.S Treasury yield curve has steepened to a four-year high, foreshadowing economic expansion and inflation, reacting to vaccines and new stimulus packages. A steep yield curve- indicating little difference between short term and long-term rates for bonds and notes- often precedes a period of economic expansion.
When the economy is healthy, investors see little cause for holding Treasuries and similar investment vehicles. Secondly, this rise in yields is a product of expectations for inflation, which makes bonds less desirable and pushes down their price, thus increasing their yield.
Inflation is expected to move toward and perhaps above the Fed’s 2% target rate that has been evasive for nearly a decade. At the Fed’s meeting in December, Jerome Powell acknowledged that the economy could see some price pressures, perhaps from rising energy.
As vaccines arrive and the economy reopens, we will see GDP and further, the global economy inevitably grow, responding to last year’s 3.5% plunge. Further the extra $1.9 trillion in America and the various stimuli across Europe, we will inevitably see a period of growth and inflation.
Low interest rates tend to influence capital flows, thus catalysing equity markets and investors care little for the low returns on bonds. As interest rates rise, all consumers and companies will tend to cut back on spending, directly impacting earnings and stock prices. This weeks yield curve has had this same effect, forcing investors how much they should spend on each € of companies earnings. Stocks that already have a high P/E ratio are in danger.
Most noticeably, we have seen expensive tech stocks suggest bearish behaviour. On Friday, shares in Tesla moved below $600 for the first time in more than three months as the yield on the 10-year US Treasuries briefly rose above 1.6%. Further, RBC are hedging with put options against Tesla and Wood’s Ark Innovation ETF. This raises the question of whether we will expect to see a significant rise in inflation and a fall in high priced stocks?
Not everyone is convinced. BMO Wealth Management’s chief investment strategist, Yung-Yu Ma is not convinced. Ma does not expect to see the 5% levels that were prevalent two decades ago. In fact, many believe that the interest rates will not go far beyond the 2% level.
Further, the movements of the overall market are not heavily suggestive of bearish behaviour to come. Despite losses at the end of February and start of March, the Dow is still up 0.3% over the last month. These rising rates scared wall street but, feelings of optimism still seem to be prevalent.
The main reason suggested by Powel and echoed by Ma is that inflation pressures will most likely only be temporary. Further, economic growth, and the earnings they will induce will most likely have a larger effect than the rising rates. If these earning rise enough, we might see stocks enjoying handsome returns over the next year, though that is not guaranteed. Uncertainty will certainly be a motif this year, but investors are cautiously optimistic.