by Brad Houle, CFA
Executive Vice President
Federal Reserve Chairman Jerome Powell in testimony to Congress last week said that the increase in Treasury bond yields is a "statement of confidence" in a robust economic outlook. Said differently, interest rates are rising for the right reasons which are anticipated increased economic growth and a normalization of inflation expectations. Rising interest rates have been top of mind for investors this year. The yield on the 10-year U.S. Treasury bond has risen .65 of a percent in 2021 to 1.56 percent. Uncertainty around rising interest rates has been a cause of some volatility in the equity markets in the past week.
Our view from our 2021 Outlook was that interest rates were going to gently rise over the course of the year as the economy recovers from the brief and sharp recession that resulted from the COVID crisis. However, over the longer-term we expect interest rates to remain low for the foreseeable future. Deflationary trends, which have a tendency to hold interest rates down, were in place prior to COVID and will likely remain after the crisis is over. There is an excess of savings in the world, labor is a global commodity and currently oversupplied and technology is a deflationary force for consumer goods. In addition, according to Bloomberg, there is $13 trillion of negative-yielding sovereign debt worldwide which is an additional factor that will keep our interest rates from rising sharply. The U.S. 10-yearTreasury bond at 1.56 percent looks very attractive to global investors in the context of other countries' debt that has a negative yield.
Should long-term interest rates climb to a level beyond where the Federal Reserve is comfortable, there are other strategies that can be deployed to control interest rates. Generally, the tool that the Federal Reserve uses most often is to increase short-term rates when they want to tap the brakes on the economy. The Fed Funds Rate, which is the benchmark for short-term interest rates, is currently zero as a reaction to the economic stress of COVID-19. To lower long-term interest rates the Federal Reserve would need to deploy a strategy called Yield Curve Control. While there are various nuanced versions of this strategy, at its core the Federal Reserve would target a specific yield on longer-term bonds such as the 5-year or 10-year Treasury and buy bonds to drive down the yield to the desired level. Bond prices and yields move inverse to one another, so by buying bonds and increasing the price of bonds it would drive down the yield. This is currently being done by the Japanese central bank as well as the Australian central bank and it was done during World War II. Lower interest rates are stimulative to the economy, as it lowers borrowing costs for corporations, consumers and the government.
This Week
February's jobs report released on Friday showed a gain of 379,000 jobs, well above the 200,000 consensuses estimate according to Bloomberg. Much of this gain was due to the reopening of the hospitality sector in many parts of the country. In addition, the unemployment rate ticked down to 6.2 percent from 6.3 percent the previous month. According to Capital Economics, the economy is missing 9.5 million jobs from the pre-pandemic level where the unemployment rate was 3.5 percent. Of the jobs lost, 3.5 million of them are in the hospitality industry which should rebound sharply as vaccines become more widely available.
For the week, the stock market as represented by the S&P 500 was up about .83 percent. The 10-year Treasury bond yield moved from 1.40 percent to 1.56 percent.
Takeaways for the Week
Interest rates are moving higher for the right reasons — primary, a resumption in economic growth as we get toward the end of the pandemic
Fears of higher interest rates and inflation have caused volatility in the stock market