If last week’s market action was a preview of coming attractions, Federal Reserve (Fed) policymakers will face more difficult decisions as the global economy fully reopens this year. Despite assurances last week from Fed Chair Jay Powell that policymakers were not close to removing accommodation — including $120 billion in monthly bond-buying — interest rates continued to climb higher. This move higher was not just limited to the long end of the curve, as the Treasury 5-year note increased more than 25 basis points during last Thursday’s trading session.
Fed policymakers have expressed little concern to-date with the recent rate rise — rather, it is simply a precursor to better economic times. The same can’t be said for the vanishing liquidity conditions in the Treasury bond market last Thursday, as bid/offer spreads for longer-term Treasuries reached the widest levels since the March 2020 market meltdown.
Last week’s damage was not limited to the bond market. Growth stocks (with longer-dated earnings and cash flows) are also feeling the impact of higher discount rates. Performance for the tech-heavy Nasdaq 100 Index is negative this year, down more than 1,300 points from February’s record high. The rally in gold has also come to an abrupt end in response to rising real yields in the United States and global interest rates turning less negative.
Bond markets in the United States are pushing back hard against signaling by the Fed that short-term rates will remain at zero through the end of 2023. We expected the biggest risk to capital markets in the second half of 2021 to be better news on economic growth and inflation, forcing the Fed to reconsider its easy money policies. The bond sell-off is speeding up that process.
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