U.S. bond yields are on the rise.
However, investors remain calm. The Dow and S&P 500 reached record highs last week, and the Nasdaq is nearing its own milestone.
The yield on the 10-Year Treasury is still comparatively low, yet it has surpassed the significant 3% mark, currently floating around 3.1%.
Concerns arise that this could merely be the start. Long-term rates might keep ascending, especially as the Federal Reserve is likely to announce an increase in short-term rates on Wednesday.
At some point, investors might begin to worry about what these rising rates could imply for consumer spending and firms seeking to borrow. Generally, higher rates may translate to slower growth for both the economy and corporate profits.
The burning question is: how many more rate hikes are on the horizon? Fed chair Jerome Powell could shed light on this during a press conference following the Fed’s decision announcement.
Craig Birk, chief investment officer at Personal Capital, noted that the market could manage a few additional quarter-point rate increases. However, many investors may have become accustomed to a prolonged period of unusually low rates.
The federal funds rate currently lies within a range of 1.75% to 2%, with expectations that it could exceed 3% within the coming year. Birk mentioned that many investors are hopeful the Fed will conclude its rate hiking cycle in 2019.
“We now have a legitimate interest rate, not just one that’s at zero,” Birk stated. “The Fed continues to indicate they will likely raise rates gradually, but the market seems to be wagering they will halt sooner.”
Birk added that the Fed has been led by “doves” — individuals like former chairs Ben Bernanke and Janet Yellen, who favored maintaining low rates — for years. Investors are now adjusting to the Fed’s new stance.
“The market is still acclimating to the realization that the Fed will adopt a more balanced and hawkish approach,” Birk explained.
In essence, investors may be underestimating the Fed’s resolve to continue raising rates, notwithstanding President Donald Trump’s criticisms regarding rate hikes or the absence of unmistakable inflation signals.
Nonetheless, some experts believe the Fed is likely to maintain its gradual approach to rate increases. Powell, similar to his predecessors, probably aims to avoid surprising the bond and stock markets with unexpected decisions.
“We do not view rising interest rates as a trigger to sell stocks, especially in the absence of rampant inflation,” remarked John Lynch, chief investment strategist at LPL Financial, in a Tuesday report.
Inflation remains manageable for the time being
While wage growth is accelerating, it has yet to spark a significant rise in consumer prices. As a result, the Fed may still have room to continue raising rates, given the robust state of the economy.
“The market interprets higher rates as indicative of improved growth, rather than signaling a policy misstep, which we find encouraging,” Lynch added.
Ed Keon, chief investment strategist at QMA, also isn’t overly concerned about inflation spiraling out of control.
“It’s premature to suggest the Fed is lagging behind,” Keon stated. “The critical question is what will occur next year and into 2020. There are some indicators that price pressures could persist. I don’t anticipate rates reaching excessively high levels.”
Keon believes the 10-Year Treasury yield could rise to a range of approximately 3.25% to 3.5%. This should still be low enough to sustain a relatively strong economy, even if growth decelerates slightly.
Thus, the most significant shift resulting from the Fed’s rate hikes could be in the types of stocks that attract investors’ attention. Technology stocks, retailers, and other consumer-oriented companies, which have been significant winners over the past year, might begin to cede ground to financial stocks.
Yousef Abbasi, global market strategist with INTL FCStone, expresses optimism for regional bank stocks (KRE) and Bank of America (BAC), which has a substantial mortgage division. They are expected to gain from higher rates as this will enhance their lending profitability.
UJ (New York) First published September 25, 2018: 11:48 AM ET
