The rise in long-term US interest rates has become a focus of global macro-financial concerns. The nominal yield on the benchmark 10-year Treasury has increased about 70 basis points since the beginning of the year. This reflects in part an improving US economic outlook amid strong fiscal support and the accelerating recovery from the COVID-19 crisis. So an increase would be expected. But other factors like investors’ concerns about the fiscal position and uncertainty about the economic and policy outlook may also be playing a role and help explain the rapid increase early in the year.
Should the US central bank control or at least attempt to shape these dynamics? Monetary policy remains highly accommodative, with sharply negative real yields expected in coming years. An overnight policy rate essentially at zero, in combination with the Federal Reserve’s indication that it will allow inflation to moderately overshoot its inflation target for some time, provides significant monetary stimulus to the economy, as investors do not anticipate an increase in the policy rate for at least a couple of years. Careful and well-telegraphed communication about the expected future path of short-term interest rates has shaped the yield curve at the shorter end.
A gradual increase in longer-term US rates-a reflection of the expected strong US recovery-is heathy and should be welcomed. It would also help contain unintended consequences of the unprecedented policy support required by the pandemic, such as stretched asset prices and rising financial vulnerabilities.
The IMF’s baseline expectation is one of continued easy financial conditions, even if US rates were to rise further. However, a tightening of global financial conditions remains a risk. Given the asynchronous and multispeed nature of the global recovery, fast and sudden increases in US rates could lead to significant spill overs across the world, tightening financial conditions for emerging markets and throwing a wrench in their recovery process.
Stocks experienced a bit of a rollercoaster this month, starting off with back to back rallying during the first few weeks of the month with back to back closes at all-time highs. That ended with news announced on Thursday, April 22, 2020 of President Biden’s “American Family Plan,” to be funded mainly by increasing the capital gains tax and the top income tax rate. Markets sold off on the news, then rebounded slightly to close the month.
The potential increase in capital gains tax has accelerated the discussion regarding whether the market has entered a value cycle, and if so, the cycle’s potential duration. During the pandemic’s earlier phases, growth stocks significantly extended the lead gained overvalue during the past decade. However, the prospect and eventual development and rollout of COVID-19 vaccines created a tailwind for value investing. Since September 2020, value stocks finally have rallied as the Russell 1000 Value Index has outperformed the Russell 1000 Growth by almost 21%. Many commentators have noted that value stocks reached an extreme discount to growth stocks last year and have remained substantially below relative historical levels even following the recent value rally.
This markets review has been prepared by the Global Markets Division of Standard Investment Bank
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