Equities Continue Setting Daily Records While Ten-Year Yield Flirts With 1.00%

December 4, 2020December 7th, 2020
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Despite Disappointing Employment News, Markets Focus on New Stimulus Hopes

Nonfarm payrolls increased by 245,000 in November from the previous month, missing the median estimate of a 460,000 gain by economists. The labor force participation rate also unexpectedly dipped, which helped drive the overall unemployment rate down to 6.7% from 6.9%, not the way the jobless rate declines in a healthy labor market. Yet the report was not so ugly that it made investors rethink the outlook for the U.S. economy as a whole. This report came on the heels of the deliberations on Capitol Hill over a new round of stimulus gaining momentum. A $908 billion bipartisan spending deal is beginning to take shape that would extend compromised relief to unemployed workers, small businesses, and state and local governments.

November’s nonfarm payrolls fell from an October level of 610,00, which was revised downward from its previously reported mark of 638,000 in October by the Bureau of Labor Statistics, which releases the monthly employment report based on data it gathers during the first half of the month. Many forecasts are now calling for a decline in nonfarm payrolls in December, which will be reported on the first Friday in January.

In November, job gains were driven by modest growth across several industries. Healthcare added 46,000 jobs, construction and manufacturing both added 27,000 jobs, and leisure and hospitality, one of the most badly hit sectors of the economy, added back 31,000 jobs (but this category is still 3.4 million jobs short of where it was in February). On the flipside, retail jobs were down 35,000 (interesting to note, Amazon is hiring about 2,800 jobs a week) and bars, restaurants, and other food-service establishments lost 17,000 jobs. Of the twelve retail subsectors tracked by the Labor Department, ten posted their worst month of the recovery.

The report showed the ways that the coronavirus is reshaping American economic life. The number of people working from home continues to tick up. The number of workers on part-time schedules increased, as did those whose unemployment was unfortunately categorized as “permanent.” The report also revealed the severe toll that the spread of infections is beginning to have on the economy, even absent the shutdowns and restrictions that many have blamed for the country’s most recent economic malaise as this survey was calculated a week before most new restrictions went into place.

A “K” recovery?

The economic crisis continues to unfold on an increasingly dual basis. On one side, the stock market has risen to record heights with investors betting on optimism about vaccine development. The fortunes of many have grown while on the other hand the economic crisis has delivered a severe blow for those at the lower end of the income ladder. For higher-waged earners, the jobless crisis has essentially ended, at least temporarily. The employment rate for people making more than $60,000 a year is up compared to January 2020, while lower-waged jobs are down nearly 20%.

There is increasing evidence that the recovery is resembling a “K” since its pandemic-driven meltdown. For many in the country who are on the up-part of the K, things are improving – job growth, income growth, low interest (including mortgage) rates, and a record equities market. But on the down-part of the K, a substantial portion of the population is hurting quite significantly. The number of Americans reporting difficulty getting enough to eat has been on a steep rise, according to Census Bureau data. About 13% of households with children reported being sometimes or often not having enough food to eat. More than a third of the people surveyed said that they are having difficulty paying for household expenses. Lines of cars stretching for miles continue to illustrate the threefold demand for basic supplies, like food.


America is at a perilous moment. The generous fiscal aid programs that helped prop up businesses and households during the worst of the pandemic have long expired, and the House, Senate, and the White House have spent months in disagreement in negotiations over further action. Unemployment benefits for an estimated 12 million people will expire at the end of the year if Washington fails to act. The virus’s surge has begun touching off a new round of closures and restrictions, as the caseload surges across a broader swath of the country than ever before.

The only retailers to show modest growth in the jobs report were furniture stores and car dealerships – more a reflection of how wealthier segments of the country have money to spend on outfitting new homes and buying new cars, than the type of robust, broad-based consumer spending that typically sustains the U.S. economy in a recovery.

Equities, interest rates rise despite these economic warning signs

The broad equity market indices have set daily record-high closes for the past two weeks. As well, the benchmark 10-year Treasury yield extended its climb this week, increasing 7 basis points (0.07%) during Friday’s session alone to just over 0.98%. This represents a breakthrough to its highest level since March, displaying the push-and-pull dynamics that bond traders have been feeling with regard to the Federal Reserve’s monetary policy and the potential fiscal aid coming out of Congress.

On Capitol Hill, it seems to be a good bet that politicians will be sensitive to headlines indicating a weaker U.S. labor market right around the holiday season and feel increased pressure to strike a deal on another round of fiscal aid. Senior Republicans are starting to get on board with the idea of accepting a $908 billion proposal from a bipartisan group of lawmakers as a basis for a compromise. House Speaker and Democrat Majority Leader Nancy Pelosi and Senate Democrat and Minority Leader Chuck Schumer already said they would use that same blueprint in negotiations.

Part of that proposal strikes directly at the heart of the softening jobs market – $180 billion would fund an extension of pandemic unemployment benefits, providing an additional $300 per week bonus for four months.

Pelosi and Senate Republican Majority Leader Mitch McConnell realize they are running out of time. New extraordinary vaccines sit on the very near horizon, helping to fuel the incredible rebound in the stock market and push Treasury yields and interest rate swaps on the longer end of the yield curve to their highest levels since the onset of the pandemic-induced economic crisis.

This week during Congressional testimonies by Federal Reserve Chairman Jerome Powell and Treasury Secretary Steven Mnuchin, Powell referred to any new round of much needed fiscal spending as a “bridge” to get the economy through the pandemic and over to the side that includes widespread vaccinations. If this latest read of the labor market is any indication, the economy is swerving but has not fallen off a cliff. It might just be enough to get Congress to act.  Powell reiterated to lawmakers that “the risk of overdoing it is less than the risk of underdoing it” on fiscal stimulus. He pointed out that the pace of improvement in the economy has significantly weakened in recent months. At the same hearings, Mnuchin said he was urging Congress to “pass something quickly.”

Pelosi and McConnell each took a stab at breaking the deadlock over new stimulus this week.

Pelosi and Schumer, who have up to just recently have been sticking to a roughly $2.5 trillion coronavirus relief package, presented a new proposal to McConnell and Mnuchin but refused to publicly release details. Schumer called it “a private proposal to help move the ball forward.”

McConnell, in response, began circulating his own plan to fellow Republicans, saying it had the blessing of President Donald Trump. While he labeled it a new proposal, an outline distributed to GOP senators showed it was largely a revision of an earlier $500 billion plan that had been rejected by Democrats as being far too inadequate. It included spending on assorted business subsidies including a revised version of the Paycheck Protection Program, as well as funding for schools, vaccines, and agriculture. It did not include a major tranche of state and local aid outside of schools demanded by Democrats and continues to include legal liability protections Democrats have considered to be a poison pill. It also featured a one-month extension of pandemic unemployment relief followed by a two-month phase-out, considerably stingier than Democrats have been demanding. McConnell characterized it as a stopgap measure, hinting that he would be open to additional relief in the future if needed.

By the end of the week, all sides began to embrace a proposal for a $908 billion compromise package offered by a bipartisan group of lawmakers from the House and Senate. The proposal was from a group that includes Republican Senator Mitt Romney of Utah and Senator Joe Manchin, a West Virginia Democrat, both who will play potentially pivotal votes on any plans from the Biden administration. The plan included some state and local aid Republicans had opposed and some pandemic liability protections Democrats have resisted.

In the upcoming days, Congress also must deal with passing a $1.4 trillion annual spending bill to fund government operations. The U.S. government has been working under a stopgap measure since the fiscal year began on October 1st. This expires December 11th. Missing the deadline would trigger a partial government shutdown. This must-pass measure has emerged as the most likely vehicle for any immediate pandemic-related relief, large or small. Senator John Thune of South Dakota, the chamber’s second highest ranking Republican, said he thought some relief, such as aid for small businesses or money for schools and vaccine distribution, should be attached to the annual spending bill.

One of the year’s biggest spikes in Treasury yields

As discussed, renewed optimism about U.S. stimulus talks pushed the benchmark 10-year yield higher, a move which, if continued, could spark a domino effect across risk assets trading at all-time highs thanks to low interest rates. At issue is whether the jump in yields is accompanied by an economic recovery and moderate levels of inflation that would allow the Federal Reserve to keep rates low.

So far, it seems investors are positioning for that scenario, with the shape of the Treasury curve, often a gauge of growth expectations, steepening and U.S. stock indices rallying to fresh records.

“A range of 1.00% to 2.00% [on the ten-year Treasury] is certainly possible and it would have wide implications across everything from emerging Asian currencies to commodities,” said the head of economics and strategy at Mizuho Bank Ltd. “It’s likely a matter of when – not if – yields will climb.”

Benchmark yields have tripled from their March lows on bets of a global economic recovery and a “return to normal” from the pandemic with the help of vaccines. A Bank of America survey last month found a record 73% of investors expecting the yield curve to continue steepening.

Here is a look at what higher Treasury yields could mean for various asset classes:

Skyrocketing Stocks

One of the clearest winners from a modest rise in Treasury yields could be equities, particularly those most exposed to a reflating economy. The MSCI AC World Index is already trading at a record high and rotation to cyclical stocks, such as industrial and materials, accelerated last month. To the extent yields rise, it is likely to be on higher inflation expectations. Periods where yields rise, and the yield curve steepens, are some of the best periods for the stock market. But key to the bullish outlook for stocks is inflation remaining under control and economic growth returning. A return to the dreaded stagflation of the 1970s, for example, would quickly derail any rally in risk assets.

Gold Uncertainty

The outlook is a little less certain for gold. If a rise in ten-year Treasury yields to 1.00% or higher is due to a reflation trade, then gold and other commodities will likely do well. However, further gains in yields might also hurt the yellow metal as demand for haven assets wane. If the market sees 1.50% or more on the ten-year Treasury yield, some precious metals analysts are calling for gold to then drop below $1,800/oz., and perhaps as low as $1,700/oz.

Credit Bonanza

Like equities, the credit market may also stand to gain from higher Treasury yields. Debt investors have been clamoring for longer-term U.S. corporate bonds as stimulus spending bolsters risk appetite, sending spreads on notes maturing in ten years or more to their tightest levels since February. Credit spreads should remain tight as long as the move higher in Treasury yields is due to a reflation trade.

U.S. Dollar Hit

Higher Treasury yields could end up weighing on the world’s reserve currency. Should the U.S. yield curve steepen as inflation expectations rise, this will incentivize investors to currency hedge. Moves by investors to shield from currency fluctuations in U.S. investments could see the dollar fall by as much as 20% next year, many analysts have predicted. Goldman Sachs, who also sees potential for more curve steepening, is forecasting a weaker dollar against most emerging currencies, including China’s yuan.

Treasury Yield Increases

Still, much will depend on the response of the Federal Reserve to any spike in U.S. yields, particularly amid the ongoing debate on its asset purchase program and expectations it will let inflation run hot if seen as necessary to increase employment. The Fed is currently buying about $80 billion in Treasuries and $40 billion in mortgage-backed bonds every month, partly aimed at lowering borrowing costs for businesses and households.

Longer-term bets around Treasuries and their ripple effects on other asset classes may hinge on how the Fed communicates. There is a huge amount of inertia in terms of Fed positioning that has so far prevented much higher yields. That is fine when the economy is in a recession but not so much when it is in a recovery mode.

Oxford Economics, a leading global markets forecasting firm, is predicting that government bond yields will keep rising over the next five years. They suggest that the combination of higher inflation, central banks building up gold reserves and pulling back on quantitative easing, and/or governments issuing extra debt, will push ten-year U.S. Treasury yields to 3.50% by 2025 from their current level of just below 1.00%.

Biden puts the Great Recession recovery band back together

President-elect Joe Biden on Tuesday announced the team that will take on one of the key early challenges of his presidency – namely keeping the U.S. economy’s recovery from the coronavirus on track. Biden’s economic officials, who mostly have Great Recession crisis experience from the Obama administration, will be charged with delivering more fiscal stimulus to support an economy that risks running out of steam after a rapid initial rebound seen from the virus slump.

The team will also be in charge of a longer-term economic plan that is a marked departure from President Donald Trump’s agenda, with a focus on boosting clean energy and domestic manufacturing, improving care for children and the elderly, and narrowing racial inequalities in income and wealth. These policies, along with short-term stimulus measures, face obstacles in a potentially divided Congress, depending on the outcome of the two Georgia senatorial elections on January 5th.

At an event to introduce his economic team, Biden said the group was put together specifically to “get us through this ongoing economic crisis and help us build the economy back better than before.”

Janet Yellen was nominated to be the country’s first female Treasury Secretary. As a Federal Reserve regional president, then Vice Chairperson, and finally Chairperson in years before and after the 2008 financial crisis, Yellen has plenty of experience at economic firefighting and that record has won her support from both sides of the political aisle. “It’s essential that we move with urgency,” she said Tuesday. “Inaction will produce a self-reinforcing downturn, causing yet more devastation. And we risk missing the obligation to address deeper structural problems.” Her nomination has been positively received by the markets given her dovish nature and propensity to spend more rather than less.

One early task may be to work with her former colleagues on the Fed’s emergency lending programs for businesses and local governments, some of which are due to run out at the end of this month. The current Treasury Secretary triggered a rare public dispute with the central bank by saying that the Fed should return the money allotted as backstop for the loan facilities, instead of extending them. Yellen will also have to navigate international disputes, especially over trade and ties with China.

In addition to Yellen, Biden introduced his nominations for the Deputy Secretary of the Treasury (Adewale “Walley” Adeyemo), Chairperson of the Council of Economic Advisors (Cecilia Rouse), members of the Council of Economic Advisors (Jared Bernstein and Heather Boushey), the Director of the Office of Management and Budget (Neera Tanden), and the National Economic Council Director (Brian Deese). Other key officials, such as the secretaries of the Commerce and Labor Departments, as well as the U.S. Trade Representative, have yet to be announced.

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