Last Week in Review: Low rates to be replaced with good times.
This past week, the meme stock short covering phenomena seemed to fade a bit. The lack of further drama, along with solid corporate earnings, pushed stocks sharply higher at the expense of bonds and rates.
All Good Things Come to an End
Interest rates hit historically low levels last year due to the pandemic outbreak and the worst quarterly decline in economic growth ever. Those rates have helped millions of homeowners refinance and save significant money on interest expense. On the purchase side, along with several other tailwinds, low rates have fueled a bonanza in housing.
Fortunately, we are closer to getting past the pandemic as vaccines are now seeing widespread distribution. This, along with enormous stimulus measures, pent-up consumer demand, and easy monetary policy, tells us the good times of ultra-low rates may have come to an end.
The Yield Curve Is Talking
Economists look at things like the yield curve in the bond market to predict oncoming recessions or periods of economic expansion. At the moment, the difference or "gap" between the 2-year note yield and 10-year yield is at the widest level in over three years. This means the bond market is telling us we are about to see an era of economic expansion. Yes, better times ahead. Bonds and rates don't like good news and better times, and it's why we have seen an uptick in rates since the beginning of the year.
Inflation Expectations at Nearly 7-Year Highs
The 10-year breakeven inflation rate, what we expect to see inflation average over the next 10 years, is just a few basis points away from the higher levels in almost seven years. With Congress batting around another $1 trillion plus stimulus bill, along with fully reopening the economy, there is reason to believe these inflation expectations will rise even further. When inflation moves higher, rates move higher ... period.
What About the Fed?
The Fed has played a pivotal role in keeping rates relatively low by purchasing $120B worth of Treasurys and mortgage-backed securities (MBS). But despite those efforts, rates have crept steadily higher with the 10-year yield moving from .50% last August to 1.15% as of this writing.
Should rates move too high too quickly, the Fed will likely do more to try and pin down long-term rates, like purchase even more bonds or invoke some sort of yield curve control.
Bottom line: Rates have crept higher, and with the anticipation of better days ahead and so much stimulus, we should expect a further uptick in rates.
