Stimulus spending is the theme that continues to defeat every other piece of news. Neither surging virus cases nor political tumult can diminish the allure of trillions in more federal spending. It’s a testament to the bull market, and propelled equities to all-time highs last week. What disrupts that calculus going forward? Two things in our view (outside of geopolitics, inherently unpredictable, although certainly an increasing risk lately):
- A Fed policy mistake – Interest rates are rocketing higher on stimulus optimism, and market-based inflation expectations are fast approaching the highest level in 3 years. The word “taper” is starting to make the rounds as Fed officials talk about slowing the pace of bond purchases. This is a delicate balancing act for the Fed, and it got it wrong twice before: in the “taper tantrum” of 2013 and with Powell’s careless comments around the balance sheet in late 2018. Both events were followed by market selloffs.
- Ineffective vaccines – The Covid situation is spiraling out of control across the U.S., but to the market, this is a temporary hit to growth and there is light ahead. A strain that can skirt the existing vaccine technology, sending scientists back to the drawing board, changes that dynamic.
Notice what didn’t make that list: impeachment; 25th amendment; unrest across the country; Covid-related restrictions. Even last week’s job report, showing the first monthly net loss of jobs since April, did not impact the bullish sentiment.
One only needs to tune into CNBC for a few minutes to hear about the retail darlings driving sentiment: Tesla and Bitcoin. The buy-the-dip mentality is incredibly strong, so much so that Wednesday’s session – despite the unrest in the nation’s capital – saw the fourth highest volume of call options traded on record. Stimulus checks, if they arrive again, add fuel to that fire, and only the new, welcome distractions of getting life back-to-normal cools down this phenomenon.
So much for boring old fixed income! Stimulus optimism is sending interest rates rocketing higher. The 5-year, 30-year yield curve closed Friday at 139 basis points, above the highs seen after President Trump’s 2016 election when tax reform and infrastructure optimism propelled higher yields. Strategists are scrambling to increase their yield forecasts. We agree the technical breaks of this past week are meaningful, and that stimulus spending will increase growth in 2021, pushing up yields at the margin.
Despite near-term optimism, we are still in a low growth world with disinflationary tendencies. Throw in the Fed’s new interest rate framework and their past experiences with balance sheet management, and we think policy remains easy for years. That is great for asset prices, but don’t bet the farm on a huge spike in yields.
What to Watch This Week
- Politics – Markets are looking past the turmoil in D.C. to happier days of a free spending Democratic government. But Senator Joe Manchin indicated Friday that he does not support $2,000 checks. Thursday may be important as President-elect Biden outlines his agenda. Pay attention to how this comes together, though the impact will be greater for the recent trends (value over growth, small over large) than for the market’s overall direction.
- U.S. CPI on Wednesday – This is the first meaningful inflation print in a long time. December’s jobs report showed an acceleration in wage gains, and although this was driven mostly by lower paying employees (leisure and hospitality) falling off the rolls due to the Covid surge, the inflation narrative is running hot among market players. An above-consensus inflation print could cause the recent rise in rates to go from a good thing to a bad thing for markets.
- Fedspeak – This has been confusing, with Atlanta Fed Bank President Raphael Bostic, a voting member, leading the charge on tapering. Does he clarify his prior comments this week? And will Chairman Jerome Powell hint that upside risks to growth may bring forward policy normalization on Thursday? Watch the dollar, finding its footing last week after sliding for seven straight months, as an early indicator of risk to the goldilocks equity narrative.
This commentary is written by Horizon Investments’ asset management team. Please reach out to Chief Investment Officer Scott Ladner for interviews at 704.919.3602 or sladner@horizoninvestments.com.
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