After the Senate passed a historic $1.9 trillion economic relief and stimulus bill a few weeks ago, the yield on 10-year Treasury notes hit 1.613%. This represents an increase of approx. 0.7% from the start of 2021 when the 10-year was below 1%. Against a backdrop of stimulus relief, increased vaccinations, and a declining number of coronavirus cases, the steepening yield curve seems to suggest that some investors are seeing the light at the end of the tunnel and believe a full economic recovery may be just around the corner. This bullish signal seems to suggest investor optimism leading investors away from traditional safe-haven assets such as treasuries toward more risky investments.
However, the swift rise in yields may not be all good news for investors. Bond yields and their price have an inverse relationship. As yields rose, bond prices have dropped rapidly in early 2021. With significant stimulus about to be injected into the economy, investors are anticipating increased inflation as they demand higher yields to compensate for heightened inflation risk. Both rising rates and higher inflation represent a vast departure from the low-rate environment we have grown accustomed to in recent years. Only time will tell if 10-year treasury yields continue to rise to pre-pandemic levels closer to 2%.
Despite a sharp rise in bond yields this year, Federal Reserve Chairman Jerome Powell may not share investor concerns about inflation pressures in the short term. In recent remarks, Powell suggested the pandemic “has also left a significant imprint on inflation”. He went on to say, “The economy is a long way from our employment and inflation goals, and it is likely to take some time for substantial further progress to be achieved.” He did not sound worried about inflation hurting the economy.
While no one has a crystal ball about the economy, interest rates and inflation, the only constant seems to be change. As stimulus checks start to hit bank accounts in mid-March, it is important for investors to consider that the effect this stimulus will have on markets and the resulting Fed policy. Investors must prepare for the possibility of multiple market outcomes, as new economic forces push and pull investors in different directions. Now, more than ever, it is important to remain diversified.
Disclaimer: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimations, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.