Daily Market Recap - Would a Moderate Rise in Interest Rates Be More of a Service to Central Banks?

In the United States, there has been a rebound in the economic surprise index in recent weeks - meaning that actual economic data is more often above consensus. This was not the case in the second half of 2020 when this index had collapsed (without affecting the mood of the American markets, which are still largely reassured by the power of monetary policy). So the question naturally arises: if equity markets were growing despite lower than expected numbers, can they fall when the economic numbers come out better than expected？ The volatility of the last few days seems to provide the answer...

The rise in medium-term inflation expectations has also played a role in the behavior of interest rates. In the United States, inflation expectations reached more than 2.4% in February, even exceeding pre-Covid19 levels, and reaching their highest level since 2018. This improvement in economic and inflation sentiment also led to an acceleration in the steepening of the US yield curve, with the spread between two- and ten-year rates reaching a level of more than 140 basis points, the highest since 2015.

It is clear that the nervousness of the markets in recent days, and particularly that affecting growth stocks, is linked to rising optimism in economic expectations, and correspondingly to underlying fears of an earlier than expected slowdown in monetary support. Despite the speeches of the presidents of the Fed and the ECB reiterating their commitment to continue to support the economies through very accommodating monetary policy.

The increases in bond yields, in both Europe and the US, have taken place without any meaningful reaction by the central banks. It remains to be seen whether an interest rate hike is even on the mind of the central bankers at the moment. If financial conditions tighten too quickly in a phase of economic recovery, interventions will be necessary in order not to impact growth, as Isabel Schnabel of the ECB indicated last week. She said, however, that a gradual increase in real rates need not be a cause for concern. On the Federal Reserve side, Raphael Bostic (Atlanta Fed) said he is not worried about the movement in rates and indicated that at this point there was no need for the Fed to respond.

One could therefore think that this rate hike if it were “orderly” and gradual, could help to ease the pressure on the valuations of certain assets which would indirectly allow the Fed (or the ECB) to control the risks of bubbles without having to modify their prospective policy indications for the moment. We have heard a few Fed members talk about high valuation levels on certain assets albeit without providing further details. A gradual increase in interest rates could limit excessive risk-taking on the financial markets while not stifling recovering economies.

(Chart Source: Tradingview 09.03.2021)

(Chart Source: WSJ 09.03.2021)

The markets will therefore be keeping a beady eye on Treasury yields and the statements of Fed and ECB members in the coming days for any signs of tightening of monetary policy.

Disclaimer: This material has been created for information purposes only. All views expressed in this document are my own and do not necessarily represent the opinions of any entity.