The week ahead will be a busy one for market-moving events and economic data. However, beyond the noise, investors will continue to mull two crucial questions: First, how far could interest rates rise and, second, what could that mean for equities?

As has been the case throughout the past year, progress against the pandemic will continue to impact markets and the economy. In the U.S., the last week saw some stalling out of recent declines in confirmed cases and fatalities. However, hospitalizations have continued to fall, which is an encouraging sign. In addition, the approval of a third vaccine in the United States should accelerate progress towards herd immunity by the summer, provided current vaccines retain effectiveness against new variants of the virus.

The week ahead will also see some important events. The annual “Two Sessions” meetings of the Chinese People’s Political Consultative Conference and the 13^th National People’s Congress kick off on March 4. While decisions on the latest 5-year plan were largely announced last November, the tone of official statements will be important. In particular, Xi Jinping will likely adopt a more cautious approach to economic growth, emphasizing a need for “common prosperity” over strong recovery. He will also want to curtail criticism of government policies, restrain speculation in the huge real estate sector and limit the growth of local government debt. Xi will likely maintain an aggressive approach towards trade and other areas of conflict with the United States, mirroring the tough stance adopted by the incoming Biden administration. While China will continue to recover from the pandemic, its relatively strong performance in 2020 and a slow domestic rollout of vaccines suggest that 2021 could be one of the very few years when growth in much of the developed world matches that of China. However, most likely, Xi will be content to see this unfold in confidence that China will retake the economic growth lead in 2022 and beyond.

The OPEC+ meeting, also on March 4, occurs at a time when crude oil prices have lurched up into the mid $60s from the low $40s last summer and fall. This favorable trend for producers reflects declining inventories due to a recovery in demand from its pandemic lows, a decline in U.S. output last year and self-imposed supply restraint from Saudi Arabia and Russia. It is likely that the OPEC+ group will agree to increase supplies, holding prices at close to current levels. If they show more restraint or underestimate the pickup in global demand, prices could rise to $70 or above. However, as has been the case for many years, such a price hike would likely trigger further surges in non-OPEC production, laying the groundwork for a decline in prices later in 2022, as the global economy slows down following a post-pandemic surge.

In the U.S., the giant $1.9 trillion Covid Rescue bill heads to the Senate having passed the House last week.  Following the ruling of the Senate parliamentarian, it now looks very unlikely that a minimum wage increase will make it into the final package. However, the overall bill still looks on track to be approved by a narrow majority in the Senate and to be signed into law by the president in mid-March.

Even as this bill comes into effect, the economy should be showing signs of strengthening. Economic data this week should include some very strong PMI readings for both manufacturing and services, reflecting continued adaptation to pandemic conditions as well as the first early dividends from some declines in case counts. Light-vehicle sales likely fell in February due to harsh winter weather and tight inventories. However, industry reports suggest very strong transactions prices, pointing to the potential for stronger sales as these restraints recede. Most importantly, the February jobs report, due out on Friday, could show a roughly 200,000 gain in non-farm payrolls and an unchanged unemployment rate at 6.3%. Wage growth likely remained strong, at 5.3% year-over-year.

While none of these data suggest that the economy is even close to full health right now, they do suggest diminishing distress. This supports the idea that the economy will be able to accelerate very strongly when the pandemic recedes and a final big dose of fiscal stimulus is delivered to the economy.

For markets, this idea should also support the idea of higher long-term interest rates. A further bond market sell off last week pushed the 10-year Treasury yield above 1.5%. Although it has since fallen back to 1.44%, stronger growth, higher inflation and further government borrowing should boost it further in the months ahead. But how far?

One reasonable target by early next year would be a return to a positive ex-post real rate, that is to say, a 10-year yield that exceeds year-over-year core CPI inflation.

From a simple micro-economic perspective, in normal times, real interest rates should always be positive. Someone who saves, rather than consumes, should demand a positive reward in real terms or else why would they save? Someone who borrows to invest should expect a positive real return on their investment or else why would they go to the trouble of borrowing? And, expecting a positive real return on their investment they should be willing to pay a positive real rate of interest to their creditors. 

Real rates did turn negative in periods in the late 1970s and early 1980s when investors were convinced that inflation, while high, was very likely to fall sharply. However, that is not the case today so there are really only two broad reasons for the existence of negative real rates. One is that income and wealth have become so concentrated that there is a surplus of funds to be invested relative to those who are willing and able to borrow. A second is that central banks, including the Fed, have massively intervened in the bond market, pushing long yields down.

However, it should be noted that both of these forces could recede going forward. The Biden Rescue plan, while a powerful stimulant to the economy, is also tilted towards lower income Americans, while the taxes to fund today’s huge deficits will likely eventually come from the pockets of the rich. In addition, despite the Fed’s current dovish tone, it could well taper bond purchases in early 2022 if, by the end 2021, growth is stronger, unemployment is lower and inflation is higher than the Fed currently projects. In short, by the first quarter of 2022, we expect year-over-year core CPI inflation to be between 2.0% and 2.5% and, barring some economic setback, 10-year Treasury yields could be in a similar range.

Finally, what does this mean for equities?  

History suggests that rising rates, from low levels, don’t pose a significant threat to stocks. Indeed, since 1963, an increase in the 10-year yield, when it has been below 5%, has normally been associated with a rising stock market while increases in yields from a higher starting point have generally accompanied falling stock prices.

While the precise 5% threshold suggested by history is likely untrustworthy, the theoretical point still makes sense. If interest rates are rising because of economic recovery, then stocks do well. If interest rates are rising because the economy is too hot and the Federal Reserve is trying to cool it down, then stocks do poorly. In the winter of 2021, we are still clearly in the first of these paradigms. However, investors should maintain a close watch on our success in battling the pandemic, the extent of fiscal stimulus and the pace of economic acceleration to make sure they are not caught flat-footed if a long-supportive bond market finally turns less friendly.

David Kelly is chief global strategist at JPMorgan Funds.