Friday's Market Minute: Interest Rates Have Aggravated The Stock Market

Higher borrowing costs have put pressure on most equities this week, particularly on growth names hinged on soaring valuations. Interest rates are rising because of expectations for better economic growth and they should continue to move up, but moderately. Inflation is a fear in the market, but it is not the main catalyst for interest rates.

The treasury market has been pricing in a more aggressive fiscal stimulus program from the Biden administration, much larger than many analysts had initially expected. The economy is already recovering, and many market participants believe that the proposed stimulus is much more than what is needed. Higher bond yields reflect improving economic fundamentals and may therefore not be too much of a damper on demand for credit. The Personal Consumption Expenditure Indicator, the Fed’s preferred inflation measure, forecasts a 1.7% increase in year-over-year inflation, well within the benchmark 2% or higher target. The additional COVID-19 relief on top of the $900 billion package from late last year could boost the 2021 federal government deficit to over $3.5 trillion. This is an unprecedented level considering a non-recessionary environment.

Economists expect inflation to perk up in the spring, along with higher prices from pent-up demand. However, they generally do not expect the increase to be sharp enough for the Fed to engage in constrictive monetary policy. Fed Chairman Jerome Powell underlined this week that the central bank would support the economy for as long as necessary, and that the Fed would clearly communicate well in advance when it starts to contemplate tapering asset purchases. Unfortunately, these remarks did not pacify the equity or bond markets this week. Until the central bank backs up its words with concrete actions, such as increasing its asset purchases or anchoring rates within a targeted range, yields could keep moving higher.

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