On the Cusp of An Economic Boom: What Does it Mean for Investors?
The Fed believes that the widely expected rise of inflationary pressures in the months ahead will be temporary. It expects both the core and headline measures of inflation to average 2.0 percent in 2022. That belief gives it the confidence to maintain its ultra-loose monetary policy until it sees “substantial further progress” toward its dual mandate of maximum employment and stable prices, which it anticipates “is likely to take some time.”
Such a reaffirmation of accommodation by the Fed would normally be a green light for equity markets, especially in combination with the massive $1.9 trillion American Rescue package. The bond market, however, says not so fast. Since the start of the year, the yield on the ten-year U.S. Treasury note has risen from 0.91 to 1.72 percent, including nine basis points last week, as the market adjusts to expectations of faster growth. There is also an element of concern that the Fed’s confidence regarding inflation may be misplaced, that the risk regarding inflation is skewed to the upside.
After closing at a record high on Wednesday, the S&P 500 index drifted lower to end the week, as bond yields climbed. For the week, the index fell 0.8 percent, leaving it higher on the year by 4.2 percent. Energy stocks led the decliners as domestic crude oil fell $4.67 a barrel on what is believed to be a temporary slump in demand. Financials and tech stocks also fell. Healthcare and communication services rose slightly. The Nasdaq also fell 0.8 percent, while the small-cap Russell 2000 shed 2.8 percent. The DXY dollar index edged higher.
How much further bond yields will rise, how quickly, and at what level will they present a real headwind for stocks?
These are the questions that equity investors are asking themselves, while hoping for the yield adjustment to abate. With the economy expected to soon begin delivering sharply stronger results, it seems unlikely that the backup in yields has run its course, although that remains to seen. Pushing in the opposite direction for stocks are rising expectations for revenue and earnings growth. According to Factset, first quarter earnings are now expected to grow by 22.6 percent, up from 15.5 percent at the start of the year. Revenue is expected to grow by 6.2 percent, up from 3.8 at year-end. The full year forecast for earnings growth is now 24.9 percent, and 9.5 percent for revenue.
The U.S. Federal Reserve wasn’t the only central bank making news last week. In Turkey, President Erdogan fired his central bank chief on Friday. Only just installed in November, the bank’s governor had raised interest rates in an effort to fight inflation. In response to the move, the Turkish currency has plunged 10 percent against the dollar. Elsewhere, Russia unexpectedly raised rates for the first time in two years on rising inflation concerns. Brazil also raised rates. And the Bank of Japan concluded a policy review by pledging to allow more fluctuation in the ten-year yield while transitioning to what it calls a “more sustainable” monetary framework.
The coronavirus pandemic continues to cast a pall over the global economy, especially in the Eurozone.
According to the Bloomberg Vaccine Tracker, the EU has administered a first dose to just 8.7 percent of the population, and just 3.8 percent has been fully vaccinated. In contrast, the UK has administered a first dose to 44.4 percent of its population, and fully vaccinated 3.3 percent. In the U.S. those ratios are 24.5 and 13.3 percent.
Consequently, Germany, France, and Italy remain in various stages of lockdown. And the EU’s temporary suspension of the AstraZeneca vaccine has slowed the effort further, while intensifying reluctance among those already hesitant to receive the shot. Some private forecasts of economic growth for this year have been revised lower as a result. Nevertheless, stocks in the Eurozone managed to edge fractionally higher last week. The EuroStoxx 50 index climbed 0.1 percent in euro terms, its third straight weekly increase. That gain fell to a modest loss in dollar terms, however.
Lastly, the U.S. and China held their first in-person diplomatic meeting of the Biden administration last week, and by all accounts it was rather contentious, as both sides outlined their grievances with the other, ranging from human rights, to trade, to geopolitics.
Sources: Factset, Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
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10The GDPNow forecasting model provides a "nowcast" of the official GDP estimate prior to its release by estimating GDP growth using a methodology similar to the one used by the U.S. Bureau of Economic Analysis. GDPNow is not an official forecast of the Atlanta Fed. It is best viewed as a running estimate of real GDP growth based on available economic data for the current measured quarter. There are no subjective adjustments made to GDPNow—the estimate is based solely on the mathematical results of the model.
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