1. Monetary policy is undeniably shifting. We are moving from an environment of unprecedented low rates and quantitative easing to tighter monetary policy. Dislocations during such a shift should be expected. It appears that the stock market, in some senses, “caught up” to these shifts as investors reassess Fed policy.
2. Rising rates and inflation may be causing tighter financial conditions. There seemed to be a widespread assumption that the Fed would raise rates to somewhere between 2.5 percent and 3 percent before pausing. Powell’s recent comments suggested rates could climb higher, especially if inflation pressures mount.
3. Interest rates have risen more quickly than is typical. Stocks can usually handle gradual increases in interest rates. Over the last month, however, bond yields spiked faster than normal, helping to trigger the current dislocation.
4. Stimulative fiscal policy is putting more upward pressure on inflation and providing cover for the Fed to be more hawkish. Tax cuts and increased federal spending are boosting growth, which is raising the prospects of an overheating economy.
5. We do not see signs of serious economic or financial problems. We have seen interest-rate-related equity selloffs in the past. We think this one looks similar and should be relatively short-lived.
6. We are not seeing a correlated decline in equity prices and bond yields. We think investors should worry if and when both stock prices and interest rates drop, but this isn’t happening now.
7. U.S. markets have been a relative safe haven. U.S. stocks have fallen around 7 percent from their all-time highs.1 In contrast, other developed markets are off around 15 percent and emerging markets have sold off more than 20 percent since their highs in January.1
Bond Yields Are Likely To Continue Rising
Since the Great Recession, investors have gotten used to very low interest rates and extremely accommodative monetary policy. This remained true even as signs of economic recovery and expansion began to take hold. That environment appears to be changing, and bond yields have now spiked to the point where they have caused an equity market selloff.
Bond market bulls would view this backdrop as a sign that the global economy cannot withstand higher borrowing costs and the Fed and other central banks are being too aggressive. We take the opposite view and believe the time of emergency low rates has long since passed. We also believe we are more than overdue for a higher interest rate environment considering the strength of both real and nominal economic growth.