U.S. equities gave up ground on each of the four trading days last week. The cumulative loss was minimal, just 0.7 percent, but stocks were unable to rally on what was mostly stronger than expected economic data. Retail sales surged higher by 5.3 percent in January, crushing consensus forecasts of a 1.1 percent gain. Industrial production was more than double consensus. The flash PMI report for February showed unexpected strength in services, offsetting a slight decline in manufacturing from the prior month. Existing home sales, building permits, and the homebuilders index all moved higher as well. Only housing starts and weekly jobless claims disappointed. The dollar edged fractionally lower last week, but the VIX saw a notable increase. After ending the prior week below 20 for the first time since the selloff began last February, the VIX closed at 22, and is moving higher to 24 in early trading this week.
Equity Markets React to Higher Interest Rates
What equity markets could not overlook was the move higher in interest rates. The yield on the ten-year Treasury note surged higher in anticipation of additional stimulus which looks increasingly likely to be close in size to President Biden's $1.9 trillion proposal. The yield rose 13 basis points to 1.34 percent, its highest level since last February. In absolute terms, the ten-year Treasury yield remains less than competitive. The year-over-year rise in the CPI, both at the core and headline levels, is 1.4 percent through January, keeping the real yield on the ten-year negative. As of last Friday, the dividend yield on the S&P 500® index was 14 basis points higher than the ten-year at 1.48 percent.
But the recent move higher in rates has narrowed the relative advantage of stocks enough to get some attention. At the election in November, the spread between the ten-year yield and the S&P 500 dividend yield was 85 basis points, although it should be noted that roughly a third of that tightening came from the rise in equities prices. How quickly bond yields rise may be just as important as how far. In a recent report Goldman Sachs estimated that a 36-basis point rise in the ten-year in the span of one month would be cause for concern. We don't have far to go to test that theory. With the ten-year at 1.36 percent in early trading this week, the rise so far in February is 29 basis points, with five trading days to go.
Will a Near-Term Rise in Inflation Pose Longer-Term Concerns?
The concern is that the next round of stimulus, on top of the $900 billion from December, with the Fed in full accommodation mode, and the incremental progress being made on the vaccine rollout, will conspire to produce a problematic rise in inflation. Inflation expectations have risen. Since the election, the ten-year tips breakeven rate has climbed from 1.74 to 2.16 percent. And inflation measures are likely to rise in the first half of the year, especially in relation to year ago levels, which may intensify the concern. And economic forecasts are being revised higher as well, especially following last month's retail sales number. The Atlanta Fed's GDPNow estimate of first quarter GDP jumped to 9.5 from 4.5 percent after the retail report. All of which would suggest that yields may continue to move higher.
But it remains to be seen whether a near-term rise in inflation might pose longer-term concerns. The Fed doesn't seem worried, at least at present. As reported last week in the minutes from the January Fed meeting, the staff forecasts both core and headline inflation to rise temporarily in the spring before receding to just below 2 percent by year-end. And last week New York Fed president Williams said that he was not concerned about fiscal stimulus being excessive.
This week's economic calendar in the U.S. includes the latest look at pricing pressures with release of the January PCE data. Also scheduled are personal spending and income, the latter of which is expected to surge due to stimulus payments. Also scheduled are durable goods orders, new and pending home sales, leading indicators, and both consumer confidence and sentiment readings.
European markets fared better last week. The EuroStoxx 50 index rose 0.5 percent in dollar terms, leaving it higher on the year by 3.1 percent. The FTSE 100 index rose by a similar amount and is now higher on the year by 2.0 percent. Asian equities continue to outperform. In Japan, the Nikkei climbed above 30,000 for the first time in 30 years, rising 1.2 percent in dollar terms, leaving it higher on the year by 7.5 percent. The MSCI Asia ex-Japan index is now higher on the year by 12.2 percent following a 0.2 percent increase last week. Chinese equities edged lower last week as trading resumed following the weeklong holiday. On Monday, however, that modest decline turned into a sharper selloff amid fears of a tighter policy stance, as the CSI 300 index tumbled 3.2 percent, leaving higher on the year by 8.5 percent.
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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There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
The flash reading of PMI is an estimate of the Manufacturing Purchasing Managers' Index (PMI) for a country, based on about 85% to 90% of the total PMI survey responses each month. Its purpose is to provide an accurate advance indication of the final PMI data.
The Purchasing Managers' Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. The PMI is based on a monthly survey of supply chain managers across 19 industries, covering both upstream and downstream activity. The purpose of the PMI is to provide information about current and future business conditions to company decision makers, analysts, and investors.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options. VIX values greater than 30 are generally linked to a large volatility resulting from increased uncertainty, risk and investors' fear. VIX values below 20 generally correspond to stable, stress-free periods in the markets.
A 10-year Treasury note is a debt obligation issued by the United States government that matures in 10 years. The 10-year yield is typically used as a proxy for mortgage rates, and other measures.
A consumer price index (CPI) measures changes in the price level of a weighted average market basket of consumer goods and services purchased by households. The annual percentage change in a CPI is used as a measure of inflation.
The 10 year breakeven rate measures the difference or gap between 10 year Treasury Bond and Treasury Inflation Protected Securities (TIPS). The 10 year breakeven rate serves as an indication of the markets' inflation expectations over the 10 year horizon.
The 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.
Personal consumption expenditures (PCE) are a measure of the outlays or how much consumers are spending. The PCE reading is released monthly by the Bureau of Economic Analysis.
Past performance is not a guarantee of future results.
An index is a statistical composite that is not managed. It is not possible to invest directly in an index.
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