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AEGIS Factor Matrices: Most important variables affecting interest rates

COVID-19. COVID-19 has been made a lesser factor both in size and on its influence for Higher Rates. There is a new uptick in coronavirus cases in the country, a potential "fourth wave", especially concentrated in a handful of states and among younger populations than in the past. Hospitalizations are also up, while death rates have fallen. While none of these metrics are favorable, the coronavirus pandemic is considered to be on the demise and is not holding back economic activity as much as it has in the recent past when it kept a much tighter lid on economic activity and rising interest rates.

COVID-19 Vaccines. This factor is inclusive of not only vaccines but actual vaccinations, as well. The favorable number of vaccines that have been produced and approved for emergency use, as well as the current number of vaccinations taking place has the market looking much less further down the road for the return of increased economic activity, as much of the economic data has shown over the past several weeks. This situation is expected to only continue to improve (assuming no virus variant crisis), allowing more openings of closed or limited businesses, more people going back to work, and an accompanying increase in consumption - one of the main factors that will lead to higher inflation, even according to the Federal Reserve's forecast. For all these reasons, this factor has been increased as an even larger impetus for Higher Rates.

Federal Reserve Policy. The Federal Reserve has a tight grip on short-term funding rates, which have not really moved since the onset of the federal funds target drop to 0%-0.25% at the onset of the pandemic-induced economic crisis. Federal Reserve Chairman Jerome Powell is steadfast in his stance that this policy will remain in place until there is substantial improvement in unemployment. However, the Fed is allowing longer-term yields to rise to levels equivalent with those seen pre-COVID without taking any action to cap these higher rates, such as through rate targeting, reducing the monthly $120 billion in asset purchases ("tapering"), nor moving more of its asset purchases more toward the longer end of the yield curve ("twisting"). Given this stance of allowing the market to push longer-term rates higher without taking any defensive action, the size of the Federal Reserve Policy has been reduced and moved toward Higher Rates.

Stock Market. The dramatic rise in the stock market, even while interest rates were falling for most of last year, is not leading to Federal Reserve nor Congressional action. All parties, at least for now, seem to be comfortable with the sharp rise in equity prices. This factor has thus become less of a factor for any needed action and moved upward from the Priced In sector and into the Surprise sector of this Interest Rate Factor Matrix.

Infrastructure/Green Spending and Fiscal Stimulus. Infrastructure/Green Spending has been deleted and added into the overall Fiscal Stimulus factor, making this a larger influence for Higher Rates. This is especially so since the passage of the $1.9 trillion American Rescue Plan.

Inflation. This is the wildcard when it comes to the level and maintenance of higher Treasury bond yields and interest rate swap levels. Both the market and the Federal Reserve forecast higher prices as the economy comes back online. However, the Fed continues to stick to its guns that this near-term pickup in inflation will be temporary as the economy adjusts to pre-pandemic levels and that they have sufficient tools to cool it down if it grows too high and/or more permanent than forecasted. However, fixed income market players, along with a great number of analysts and economists, are concerned that the Fed may be wrong on one or both counts. This is in fact the leading cause of rising long-term yields. So, the Inflation factor is much less of a Surprise and is indeed an expectation, so this factor has been lowered as being Priced In as it is being born out in the market with rising interest rates since the January senate runoff elections in Georgia.

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