So inflation is back.
Inflation posted hotter than expected in both the consumer and producer price indices. Hope of the Fed cutting rates any time soon is pretty much dead. In fact, investors now expect higher rates going forward, not lower.
Higher inflation expectations have pushed bond yields higher, and many have broken through important technical barriers. Friday’s close on the 30-year US Treasury yield is the highest closing level since June 2007 — this may indicate that higher yields are to come as markets reset expectations completely.
On Wednesday, we see earnings from Nvidia and Walmart, both important to keep the market upside narrative alive. Higher bond yields puts downward pressure on stocks, and the rally may be tested this week. Though, with earnings in the 27%+ range, I expect downswings will have a floor under them.
Portfolio Implications
Fixed Income. Long US treasuries, high-quality corproate bonds, and even tax-free municipals are starting to look attractive at these levels, though we may suggest waiting to enter until the market finds a new equilibrium.
Equities. While earnings are good, there are indications that this market is fragile to shocks. Nvidia missing earnings or the Fed minutes revealing a more hawkish FOMC may subject the market to a short-term downdraft.
Alternatives. The case for alternatives, like non-traded oil and gas interests is benefiting from higher energy prices. However, sustained bond yields above 5% would compress equity multiples and put downward pressure on private equity and venture capital. Private credit and real estate will also suffer as refinance rates are considerably worse.
Chart of the Week
This week’s chart comes to us from the Federal Reserve’s FRED database, and it shows the 30-year US Treasury yield from 2007 to today. The 5% yield mark is significant for two reasons. First, it marks the first time in 20-years that we have seen this level, so it is a significant shift in the regime we’ve had from then to now. Second, the period from the 1980s to 2020 was a period of almost-entirely declining interest rates. 1% in 2020 may represent the very bottom of that multi-generational trend. With today’s yields, we may be in a new trend of generally-upward interest rates. Or, at least, a sideways market for yields. Either way, it represents a firm break with the past.
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