Taper Tantrum 2.0? Don’t Count on It.
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Last Week: Long term interest rates traded flat and equities rebounded to a record high following the peaceful inauguration of President Biden, the issuance of multiple executive orders and expectations of a sizable COVID-19 relief package. The yield on the benchmark US 10-year Treasury note dropped a basis point to 1.09% from 1.10% this time last week. For short term rates, 1-month LIBOR fell about one basis point to 0.124%, as daily SOFR fell three basis points to 0.04%. The price of a barrel of West Texas Intermediate crude oil advanced, rising to $52.43 from $52.00, while the US Dollar weakened, and Gold strengthened. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, descended throughout the week.
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President Biden hit the ground running. The President signed or expects to sign roughly 20 executive orders in the first days of his presidency to address challenges ranging from the COVID-19 pandemic to the student debt crisis. Many of his orders reversed those issued by former President Trump, including the so-called Muslim travel ban, construction of a southern border wall, masks and physical distancing in all federal buildings and on federal lands, and intentions to tackle global warming by rejoining the Paris climate agreement.
Biden will also ask the US Department of Education to extend the pause on interest and principal payments for direct federal student loans until at least September 30th, and he has plans to get children back in the classroom. Included in Biden’s health-related orders is a reversal of former President Trump’s decision to withdraw from the World Health Organization, as well as a national mask mandate applying to planes, trains, ships, and intercity buses. The president will enact the Defense Production Act to compel companies to prioritize pandemic manufacturing supplies, and he will issue executive orders to boost food benefits and bolster workers’ rights.
Our Take: While certainly ambitious, we expect a good portion of the President’s initial COVID-19 plans to be stunted by the Senate, and that the President’s efforts will eventually be re-focused more on vaccine distribution than on stimulus payments or increasing the minimum wage. Republicans in the Senate will likely whittle the President’s $1.9 trillion stimulus plan down significantly, and make it tough to get an immediate, sizable plan passed.
US Treasury secretary nominee Yellen says “go big”. Janet Yellen, former Chair of the Fed and President Biden’s nominee for US treasury secretary, towed the President’s line by urging lawmakers to act big on the next coronavirus relief package, adding that the benefits of a higher debt burden outweigh the costs. Yellen told the Senate Finance Committee that the US could afford a higher corporate tax rate if it coordinates with other economies, with the caveat that any such rise must wait until the US overcomes the coronavirus. She also said that the country will not seek a weaker dollar to gain a competitive advantage and should oppose any attempt by other countries to do so.
Mixed economic data created suspense around the state of America’s economy. In a light week for economic data, jobless claims totaled 900k for the week ended January 16th, which was slightly below the 925,000 estimated. Elsewhere, homebuilding and permits surged in December as historically low mortgage rates supported the housing market, but homebuilder confidence fell from a record high due to a spike in US lumber and land prices. Finally, the Philadelphia Fed manufacturing index – a monthly survey of manufacturers business activity – soared to the highest level in January since the start of the pandemic, pointing to stronger factory momentum – and therefore employment – at the beginning of the year.
Our take: Last week’s manufacturing data is diametrically opposed to what was a weaker-than-expected Q4 for the all-important US consumer and creates suspense in markets about the current state of America’s economic momentum. The data deluge in the days ahead and beyond (see “What to Watch” below) will help to confirm or disprove perceived light at the end of the pandemic tunnel. We expect that near-term factory performance will soften – and thoughts of a job creation turnaround will dim – but on whole, both will fall short of the sharp contraction seen last spring. Looking ahead, progress on the vaccine rollout will be critical in determining how quickly green shoots emerge this spring.
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What to Watch This Week: Key economic data releases await in the days ahead, specifically the durable goods report (Wednesday), Q4 GDP and jobless claims (Thursday), and PCE inflation, employment cost index and consumer sentiment (Friday). All told, we expect the summation of the data will show a more vigorous finish to 2020, and one that will largely translate into greater economic momentum at the start of 2021, particularly now that the $900 billion of fiscal stimulus passed in late December will ultimately bolster the spending power of hard hit low and middle-income households.
What’s the fly in the chardonnay? The potential that the tenuous signs of improving public health, such as falling hospitalization rates, will be upended by new, more contagious variants of Covid-19, which could lead to stricter lockdown measures and downgraded economic projections. Additionally, the slow pace of the vaccine rollout could become even slower, or the multiple vaccines end up being much less effective at slowing the spread of the virus than hoped for.
Key events this week: the Fed meets for its first monetary policy meeting of the year on Tuesday and Wednesday. No one expects the Fed to change its interest-rate policy nor the pace of asset purchases.
We’ll be focused on the Fed’s economic assessment and the tone of Chair Powell’s press conference (both on Wednesday), where we expect the Fed Chair to continue to squash speculation that the Fed is having internal discussions on tapering its bond purchases later this year (if you’re not aware, the central bank is buying around $80 billion a month in Treasuries along with $40 billion in mortgage-backed securities in an effort to keep interest rates low). If we don’t hear the same echo of denial from the Fed Chair that he’s stated recently, we could see a selloff in longer-dated U.S. government debt, pushing long-term rates higher and steepening the Treasury yield curve. With this much easy money sloshing around the economy, markets fear a second recurrence of 2013’s taper tantrum, when former Fed Chairman Ben Bernanke’s hint of an early paring of Fed bond purchases jolted long-term yields unexpectedly.
Curious on where rates are headed through all of 2021 and why? Check out our 2021 Interest Rate Outlook.
Big Picture: The 10-year Treasury yield is close to re-testing 10-month highs amid a brighter growth outlook and expectations for additional virus-relief aid from Congress. The 10-year yield previously reached a 10-month high of 1.186% on January 12, the highest level since March, after some regional Fed presidents indicated they are open to paring the Fed’s bond purchases – aka “tapering” – this year. The 10-year yield has since drifted lower after Fed Chair Powell beat back tapering speculation in recent public comments.
While exciting to think about, we doubt we’ll see another taper tantrum. The passage of the $900 billion fiscal stimulus package since the Fed’s last meeting in December has likely bolstered the Fed’s confidence that the economy won’t backslide into recession, even though the jobs market – the Fed’s top priority – deteriorated recently. Even so, while striking an optimistic pose, Chair Powell will intentionally fall far short of hinting that a shift in the Fed’s easy money stance will be considered anytime soon and is more likely to state that the Fed stands ready to do even more to stimulate growth if necessary – the exact opposite of tapering. We don’t expect to see any real change in the Fed’s growth-stoking stance until mid-2021 at soonest, and even then, it will be telegraphed with great nuance ahead of time so as to avoid any negative market reaction.
Current Select Interest Rates:
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Source: Bloomberg Professional
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Source: Bloomberg Professional
