Rising Bond Yields Are a Sign Economic Recovery is Expanding

The continued rise of long-term U.S. Treasury yields reverberated throughout financial markets over the past week. Even though the yield on the benchmark 10-year note briefly exceeded the estimated annual dividend of the S&P 500 index, we view the recent reflation as the sign of a healthy and broadening economic recovery.

This is part of a larger shift that began in the fourth quarter of 2020, starting in the manufacturing sector. The services side has since followed suit as business restrictions have gradually been loosened. Consumers have been building up savings, and the cyclical recovery could further expand once wider vaccine distribution allows for safer travel. In addition, corporate earnings exceeded estimates in the fourth quarter of 2020 and are expected to post double-digit growth in each of the next seven quarters.

It’s true that rising interest rates can cut into asset prices, especially when hyper-growth is being modeled several years out into the future. However, for investors with a balanced, diversified approach, the U.S. economy is being supported by fiscal and monetary policy and appears to be primed for a post-pandemic recovery.   

WALL STREET WRAP

Powell Sticks to Dovish Plan: Fed Chair Jerome Powell doubled down on his accommodative policies during two days of testimony on Capitol Hill last week, noting that the “recovery remains uneven and is far from complete.” Powell maintained that recovering millions of jobs lost during the pandemic remains a priority and that it could take three years or more for inflation to reach the Federal Reserve’s target. On that front, the Bureau of Economic Analysis said on Friday that the core Personal Consumption Expenditures (PCE) price index increased just 1.5 percent from the previous year, excluding food and energy. This is the Fed’s key measure of consumer inflation, which was running at 2 percent back in 2018, when Powell last increased short-term interest rates.

Durable Goods Show Manufacturing Demand: On Thursday, the Census Bureau announced robust 3.4 percent growth of new orders for Durable Goods in January. The reading surpassed expectations and marked the fastest growth in six months, while the December figure was also revised higher. Below the headline number, shipments of non-defense capital goods excluding aircraft also increased 2.1 percent last month. This figure represents big-ticket business spending and is a direct part of the GDP calculation each quarter.

Third U.S. Vaccine Approved: Johnson & Johnson received FDA approval on Saturday for its COVID-19 vaccine. This marks the third vaccine to receive emergency approval for use in the U.S. and the first designed to be administered in one dose.

More than 70 million doses of COVID-19 vaccines have been administered in the U.S., with an estimated 7 percent of the population having already received both shots of either Moderna’s or Pfizer’s versions. At the current rate of 1.45 million patients a day, the U.S. could achieve 200 million doses by Memorial Day. Adding a third (and single-shot) vaccine will likely push those targets forward, allowing for more parts of the U.S. economy to re-open this spring.

Consumer Confidence Returns: On Tuesday, the Conference Board said that its Consumer Confidence survey increased to 91.3 in February. An increase in the present situation reading was offset by lower future expectations. Recent direct stimulus checks and the continued vaccine rollout are two likely factors behind the improved sentiment.

Many consumers are spending stimulus checks, but many others are saving the money. As reported by the Bureau of Economic Analysis on Friday, the U.S. savings rate increased to 20.5 percent of disposable personal income in January, or a total of $3.9 trillion. The same figure was just $1.2 trillion a year ago, before the pandemic started. Another $1.9 trillion of economic relief passed its first test in the U.S. House of Representatives early Saturday and will now be debated in the Senate. With the Democrats in control of both chambers, it’s likely some version of that stimulus will pass, and consumers could increase spending or potentially further add to their cash reserves in the first half of the year.

Earnings Season Recap: A full 96 percent of the S&P 500 companies have reported quarterly earnings for the fourth quarter of 2020. Aggregate profit is running about 5 percent higher than a year ago, which is considerably higher than the consensus expectation at the beginning of January for a 9 percent earnings decline.

Looking at 2021, Refinitiv expects that aggregate earnings growth for the S&P 500 will expand to more than 23 percent. This includes improvement in all 11 sectors (up from just 7 last year), led by cyclical groups such as Energy, Industrials and Materials.   

THE WEEK AHEAD

ISM Kicks Off Busy Week: The Institute of Supply Management will post February Manufacturing data on Monday, followed by its report from the Services sector Wednesday. Taken in concert, these readings offer a comprehensive view of U.S. economic activity.

Beige Book Offers Regional Outlook: The Federal Reserve will release its Beige Book report on Wednesday, offering an economic snapshot from each of its 12 districts. In recent weeks, we’ve already seen reports of increased manufacturing activity in from the Dallas, Kansas City, New York and Philadelphia districts.

Jobs Growth Expected to Return: The February employment data will be reported on Friday, which will offer a progress report of the Fed’s push to resuscitate the U.S. labor market. Last week saw a sharp decline in the weekly initial jobless claims, but it’s too early to tell if this is a sustainable trend.

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