by Bryan Perry

March 16, 2021

When we think about what to write about every Sunday afternoon for the week ahead, we columnists try to weigh the forces that will impact the market most – like how the bond market will trade in front of this week’s FOMC meeting – so we first must weigh the latest words of the Fed Chairman on that subject.

We’ve heard Fed Chair Jerome Powell speak of current inflationary pressure as “transitory,” saying that any upward pressure will subside in the months ahead as global supply lines stabilize. The bond and stock markets took that narrative to heart, with the Dow and S&P 500 trading to new all-time highs, led by value and cyclical stocks. The rotation into reopening sectors continues at the expense of growth stocks.

However, Friday’s close for the 10-year Treasury yield at 1.64%, the highest level in more than a year, could be a tipping point for a couple of reasons. First, those sectors most levered to the economy maintained broad upward momentum, where a swath of leading cyclical and value stocks are very overbought on a short-term basis. The second, and more important tell, was how the Nasdaq opened lower by 200 points and closed off by only 78 points, even as the bond market closed at the low of the day.

While there are singular arguments why bond prices are under pressure, one can make a base case that there are five reasons bond yields are rising on a collective basis.

  1. Organic economic growth is accelerating.
  2. Commodity prices will continue to rise.
  3. More big spending by Congress on infrastructure and healthcare is coming.
  4. Higher wages will lead to higher prices for services.
  5. The dollar will eventually decline under the weight of the growing national debt.

#1: Economic growth statistics are evident everywhere, so let’s examine the other points in more detail:

#2: The Producer Price Index for final demand increased 0.5% (m/m) in February, following a 1.3% increase in January. On a year-over-year basis, the Producer Price Index was up 2.8% in February, the largest year-over-year jump since rising 3.1% for the year ending October 2018. Briefing.com reports, “…there were no surprises in the headline numbers, so the stock market could choose to turn a blind eye to it, but there was a sightline to pipeline inflation pressures, as the index for processed goods for intermediate demand rose 2.7% m/m (up 6.6% yr/yr), the largest monthly increase since July 2008.”

The CRB Index traded through its pre-pandemic high this past week – like a hot knife through butter.

Producer Price Index by All Commodities Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Also, shares of the Invesco DB Commodity Index Tracking Fund (DBC) had a strong week, rallying on surging volume. It is now challenging a significant overhead resistance level (blue line), If breached, it could open the way higher.

DB Commodity Index Tracking Fund Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

#3: More big spending ahead.” Forbes released an article on March 1, titled, “Biden’s Infrastructure Bill Could Be $2 Trillion Behemoth. Here’s What Goldman Sachs Is Expecting.”

The article’s Key Fact is: “Goldman Sachs laid out their expectations for his forthcoming infrastructure spending initiative—the second phase of his ambitious plan to revitalize the American economy. In a research note late Sunday, Goldman Sachs’ analysts said they expect the proposal will be worth at least $2 trillion—and potentially even double that—over the next 10 years based on previous proposals and estimates of how much investment will be necessary to shore up U.S. infrastructure.”

The Associated Press reported that the White House could release its proposal sometime this month. As the $1.9 trillion Covid-19 package is being financed with debt, this massive infrastructure package will be financed with debt and a big tax increases. (The chart below does not include the $1.9 trillion package.)

All Government Spending versus Revenue Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

#4: Higher wages: Despite the loud rhetoric about low wages, real average hourly earnings increased 3.4% from February 2020 to February 2021. The change in real average hourly earnings combined with an increase of 0.6% in the average workweek resulted in a 4.1% increase in real average weekly earnings over the last year (source: www.bls.gov). Any sweeping passage of a $15/hour minimum wage at the state level will drive these numbers higher in the months ahead and will factor into the forward inflation data.

According to the Congressional Budget Office (CBO), Biden’s “American Rescue Plan Act” will widen the deficit by $1.163 trillion this year and $528.5 billion in 2022. Fitch placed the US Sovereign Rating of ‘AAA’ on Negative Outlook in July 2020. The rating agency noted that despite a stronger economic recovery, the $1.9 trillion in new deficit spending and proposed future deficit spending puts the prospect of debt stabilization further away as general government debt will rise to 127% of GDP this year.

United States Public Debt Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

#5: The trend in the U.S. dollar. So far, it’s a tug-o-war between historical responses to higher yields and the weight of accelerating debt and deficit spending. The bond market has entered a twilight zone and it’s up to the stock market to accept the notion of higher rates as a byproduct of all the above components.

The recent spike in bond yields provided a much-needed boost to the Dollar Index, coming off an important support level at 90. So far, the bull case for a higher dollar is paying off. Stronger economic growth, broader progress in vaccinations, higher Treasury yields, a Fed that is too dovish and short covering from an overly crowded position by institutions has the greenback pushing higher this month.

United States Dollar Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

“There will be no peace until U.S. 10s reach 2%,” said Kit Juckes, global macro strategist at Société Générale, in a note. As yields rise, the dollar rallies, but when yields settle at a new level, the dollar drops back. The pattern probably goes on until bonds find an equilibrium, unlikely before 10-year note yields have a 2-handle, judging by taper tantrums and past cycles,” he said (MarketWatch, March 14, 2021).

Put it all together and what would normally be just another “stay the QE course” FOMC rate decision set for Wednesday March 17, this week’s Fed policy meeting is a huge barometer for market sentiment and how the bond vigilantes react. There is an underlying feeling that Jerome Powell should address what the market is worried about, acknowledge that Fed policy is flexible to changing the tone on “transitory” inflation, and that they should adjust QE guidelines and respond with the appropriate tools necessary.

In all probability, the yield on the 10-year T-Note is going to 2%, but how it gets there is important. A gradual course, over a few weeks or longer, will likely be generally well-received by the stock market, while a spike from 1.65% to 2.00% in a matter of days will test the mettle of Nasdaq and the tech sector that accounts for two-thirds of stock market capitalization. Let’s hope Mr. Powell gets it right this time.

All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.

Please see important disclosures below.

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About The Author

Bryan Perry

Bryan Perry
SENIOR DIRECTOR

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry

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