Things are getting interesting
Interest rates are up, and highflying technology stocks are down. The US dollar is up versus major world currencies, and oil is higher.The global economy looks encouraging despite recent stock market performance. Economic growth is returning as the world is emerging from pandemic lockdowns. This isn’t surprising because, even though no one knows what to expect (after all, the last pandemic was 100 years ago), some economic and market metrics make sense.
Higher yields – but only so far
Since economic growth is picking up, bond yields are moving higher. While the Fed has said it has its eye on inflation, it does not want to get in the way of economic growth and is comfortable with some increase in interest rates. But the Fed is also dovish and will keep an eye on inflation while allowing some flexibility with interest rates. After all, we are nowhere near the Fed’s 2% inflation goal. So, while the market reacted strongly to some interest rate increases (especially in the 10-year treasury) it is not a curve that’s going to go straight up. The Fed will intervene, just not now.
Stronger dollar, higher oil
As interest rates rise, the dollar strengthens. Demand for dollars and holding US assets will continue to increase. The dollar will remain strong in this environment.
Oil prices typically wouldn’t move higher as the dollar moves higher, but we have global cooperation on output limits, driven by an agreement between Saudi Arabia and Russia. There has been a drop in oil exploration and a decrease in the potential for new production So, we will see economic growth moving faster than oil output. It looks likely that oil prices will continue to rise in this environment. Russia and Saudi Arabia rely too much on oil revenue to let oil prices tumble, or to let production be limited in a meaningful way. They are trying to hit a happy medium which will probably keep oil prices buoyant. Also, basic supply and demand dynamics will be in place for some time. Demand for oil is not going anywhere anytime soon, despite alternative energy initiatives, but supply and future projects to add to production are almost nonexistent.
A little inflation, but nothing painful
Some inflation will be present, and it is reasonable to expect, as the economy strengthens, prices will rise. TIPS spreads are increasing, indicating the market’s anticipation of more inflation. But too much inflation can choke economic recovery, and the Fed will simply not allow that. The Fed will stay in front of this curve and we will see economic growth continue.
Stable markets with occasional panic
This bodes well for the markets and an overall investment portfolio. Highflying tech stocks will continue to have much greater volatility because change will come more rapidly and frequently, and markets will continue to react with greater volatility.