Rising Long-Term Yields Don’t Imply Fed Hikes
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Last Week: Short- and long-term interest rates both rose, as equities rallied sharply on the week, with several major US indices closing in record territory on Thursday. Steadier bond yields and improving coronavirus trends helped support the advance. The 10-year US Treasury yield consolidated just above the choppy 1.50% -1.60% range, wrapping the week at 1.62%, a one-year high. 1-month LIBOR floated off its recent lows to 0.11%, while SOFR held near a rock bottom 0.01%. The price of a barrel of West Texas Intermediate crude oil was little changed from week-ago levels at $65.35, while the US Dollar weakened, and Gold strengthened. Treasury yield volatility, a hidden driver of the cost of rate caps and swaptions, wrapped the week about where it started, and remains elevated. If you’re in the market for a rate cap, we suggest you check the price on a regular basis as it’s likely moved higher than you think.
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The next wave of massive fiscal stimulus is a done deal – what does it mean for rates? President Biden signed the $1.9 trillion stimulus bill last Thursday. Checks in the amount of $1,400 will be distributed to Americans below certain income thresholds, and billions in aid will flow to state and local governments. Secretary of the Treasury Janet Yellen said funds will begin to be deposited in individuals’ accounts as early as this week. For some perspective, the stimulus checks in this latest round are worth $412 billion, dwarfing the $164 billion in the December round of aid and $281 billion in the CARES Act; unemployment benefits will run at $300 per week through early September, worth over $200 billion; states and localities will share $350 billion in direct aid; school funding amounts to over $160 billion; and $48 billion is allocated to virus testing and tracing. With a cost of $1.9 trillion – 9% of GDP – this latest round of fiscal stimulus drives the cumulative deficit impact of pandemic relief to $5.2 trillion.
Our take: Biden’s massive stimulus will likely bring America’s economy back to the levels of growth seen before the pandemic, probably by midyear. To be specific, coming alongside accelerating vaccinations, the package is large enough to lift America’s rate of economic growth above 7% on a Q4-over-Q4 basis this year. If we get there, it would be the fastest pace of growth seen since 1983.
Though we expect the pace of new job creation to also accelerate in the coming months, a full recovery in the jobs market will come long after the new high-water mark for economic growth. While it’s easy to get caught up in the post-pandemic recovery euphoria, remember that as of February, 9.5 million extra Americans were still out of work from the year prior, equating to a jobless rate of about 9.1% after accounting for those who have exited the labor force. As we’ve said for months now, the Fed is mostly focused on creating the conditions necessary for a jobs rebound, which, while improving, remains elusive. As such, the scope of job creation, not the pace of economic growth nor the level of long-term interest rates, will guide the Fed’s hand in the months ahead. While higher long-term Treasury yields continue to reflect improving economic prospects, the Fed will refrain from taking away the monetary stimulus punch bowl until the jobs situation improves markedly. In the meantime, it’s wise to ask yourself how your current or anticipated projects will fare in this new world of higher long-term interest rates.
Key Part of Treasury yield curve signals increasing bets of earlier than expected Fed Hike. While we most often highlight movements in the short-term interest rates like 1-month LIBOR or long-term rates like the 10-year Treasury yield, it’s movements in 5-year tenor that are increasingly reflecting medium-term expectations for Fed policy. Five-year Treasury yields have become unmoored in recent weeks, surging amid speculation that the Fed will need to start a cycle of rate hikes perhaps a full year earlier – in late 2022 – than Fed officials have indicated. Another signal is from the swaps markets, which are reflecting a roughly 75% chance the Fed lifts rates from near zero in the same time frame. It’s a dynamic that will be explored more in the midst of this week’s Fed meeting – keep reading for more detail.
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Date for LIBOR’s demise is set for June 30, 2023 – are you ready? The movement toward replacing LIBOR got real over the last couple of weeks, as LIBOR’s regulator and administrator announced that banks that publish 1-, 3-, 6- and 12-month LIBOR won’t have to legally do so after June 30, 2023. The announcement marked the end of the road for LIBOR and has sent lenders and borrowers scrambling to figure out what it will mean for their floating interest rate loans, interest rate caps and swaps. We speak with clients literally every day about LIBOR’s sunset, eliminating layers of confusion and outlining actions that need to be taken now to ensure that the event doesn’t resolve to their financial detriment. Trust us when we tell you, if you’re a lender, borrower, legal counselor, accountant or investor who has exposure to LIBOR and you’ve ignored LIBOR’s looming sunset up to this point, you need to start paying attention. The sooner you understand how the transition impacts your specific situation, the better. Contact us or register for our LIBOR transition webinar series (see above) to get educated – it’s free.
What to Watch This Week: It’s all about the Fed meeting this week, where Chair Jerome Powell & Co. will remain firmly committed to the easy-money glide path they instituted in 2020 for both interest rates and asset purchases, even though the economic outlook has improved of late, particularly in response to the latest round of fiscal stimulus. The post-meeting press conference will likely focus on questions about the rise in bond yields, inflation concerns, regulation, and the timing of any move to ease back on the stimulus throttle. Fed Chair Powell will likely nod to improving jobs numbers and accelerating vaccine rollouts while staying committed to the current policy by pointing to the long recovery road ahead.
Outside of the press conference, all eyes will be examining the Fed’s new economic forecasts and interest rate projections. While faster economic growth should eventually result in faster job creation, upgrades to the Fed’s inflation expectations will be modest, giving them further leeway to continue the “steady as she goes” policy status. The Fed will continue to stress that they are looking beyond any evidence of transitory inflation that is not part of a higher wage – higher consumer price feedback loop. All told, while some on the Fed’s policy committee may further lean toward rate hikes down the road, the center of the governing body will remain resolved to hold the course.
On the economic data front, there are several releases which will further shape expectations for near-term growth, including retail sales, industrial production, and business inventories (Tuesday), housing starts (Wednesday) and early glimpses into March manufacturing activity from the New York (Monday) and Philadelphia (Thursday) Fed districts.
Big Picture: Here we go again. Rates markets are pricing in what they see as a growing probability that the Fed will hike sooner than it’s broadcasting. It’s important to remember that rising long-term yields don’t imply Fed hikes. We saw this same dynamic back in 2010, 2013 and 2014, where, after the 2008-9 financial crises, markets consistently priced for a pace and magnitude of interest-rate hikes that weren’t realized until years later in 2015. Expect the same this time around, where markets stage similar price action as the economy recovers.
Despite the ballooning optimism, there are reasons to think the economic recovery won’t be a smooth transition to post-pandemic normalcy. Rapid economic reopening is not assured, and households and states that are not income constrained could find it difficult to quickly spend extra stimulous funds. Economic supply will need to keep up, and prices for goods and services are rising.
Is your debt portfolio prepared for the new world of higher interest rates? Call us to find out.
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Source: Bloomberg Professional
Source: Bloomberg Professional