S&P 500 posts record high as 10-year T-note yield falls to 3-month low
Bipartisan group of Senators say they agreed on an infrastructure proposal
U.S. consumer sentiment expected to improve but remain below pre-pandemic levelsS&P 500 posts record high as 10-year T-note yield falls to 3-month low — The S&P 500 index on Thursday rallied to a record high as stock investors continue to bask in the glow of low interest rates and massive Fed liquidity.
Despite the current surge in the economy and inflation, the 10-year T-note yield yesterday eased to a 3-month low, illustrating that fixed-income investors are not particularly worried right now about inflation, QE tapering, or an eventual Fed rate hike.
Yesterday’s decline in the 10-year T-note yield was particularly striking since it came on the same day as a very strong CPI report. The May CPI report of +0.6% m/m headline and +0.7% core was stronger than expectations of +0.5% for both measures. On a year-on-year basis, the May CPI rose to +5.0%, and the core CPI rose to +3.8%. On a 3-month annualized basis, the headline CPI surged by +8.4%, and the core CPI surged by a similar +8.3%.
The fact the 10-year T-note yield yesterday was able to fall to a 3-month low despite the CPI report illustrates that the markets agree with the Fed that the current inflation surge will be transitory. Inflation is currently being pushed higher by various factors related to the reopening of the global economy, which include higher auto and housing costs, higher fuel and commodity prices, supply chain bottlenecks, and a host of other problems.
However, the market so far believes that the global economy is still in a multi-decade low-inflation environment that will re-emerge once the global economy gets past pandemic disruptions and returns to normal.
Indeed, inflation expectations peaked in mid-May and have moved lower in the past several weeks. The 10-year breakeven inflation expectations rate rose to an 8-year high of 2.59% in early May but has since fallen by about one-quarter point to post a new 1-3/4 month low of 2.31% yesterday.
However, the complacent attitude in the bond market could soon end as the Fed’s QE tapering date comes closer. A formal QE tapering announcement is still probably several months away, but the increased talk about QE tapering raises the possibility of at least a mini QE taper tantrum.
The Fed has telegraphed fairly clearly that it will begin its discussion of QE tapering at the FOMC meeting next Tuesday and Wednesday. However, the markets are not generally expecting an early warning of QE tapering until perhaps the Fed’s August Jackson Hole conference or the September 21-22 FOMC meeting.
A survey taken by Bloomberg in late April found that the largest percentage of respondents (45%) expect the Fed to provide an early warning of QE tapering in Q3 and then make a formal announcement in Q4. Only 14% of respondents expect an earlier formal announcement in Q3. A large contingent of respondents (40%) is not expecting the formal QE tapering announcement until 2022 or later.
Aside from lower bond yields, the stock market is also seeing support from the fading pandemic. The 7-day average of new U.S. Covid infections fell to a 14-month low of 14,765 last Friday and has since moved sideways. The CDC says that 42.5% of the U.S. population is now fully vaccinated and 51.8% of the U.S. population has received one vaccination dose. The pandemic situation has improved enough that restrictions are quickly ending, including the re-emergence of public sporting and entertainment events.
Bipartisan group of Senators say they agreed on an infrastructure proposal — Republican Senator Romney said yesterday that the bipartisan group of ten Senators have agreed on an infrastructure proposal to offer to Democratic and Republican caucuses in the Senate and the White House. However, there were few details and the proposal still seems to be a work in progress.
Mr. Romney said the bipartisan group has an agreement on pay-fors, which is the biggest obstacle for a deal. Republicans have so far been talking mainly about user fees and re-purposing unused pandemic aid money. However, President Biden has rejected user fees since that could be considered a violation of his pledge not to raise taxes on people earning less than $400,000. The bipartisan agreement reportedly includes a hike in the gas tax tied to inflation indexing.
The markets continue to doubt that there will be a bipartisan infrastructure bill. The markets are expecting the Democrats to soon proceed with their own infrastructure bill, with budget reconciliation in the Senate.
U.S. consumer sentiment expected to improve but remain below pre-pandemic levels — The consensus is for today’s preliminary-June University of Michigan U.S. consumer sentiment index to show a +1.3 point increase to 84.2, recovering part of May’s -5.4 point decline to 82.9.
Before falling in May, the U.S. consumer sentiment index in April rose to a 14-month high of 88.3. However, that 14-month high was still a hefty -12.7 points below the pre-pandemic level of 101.0 seen in February 2020.
Consumers are happy that the pandemic is nearing an end. However, consumer sentiment has still not fully recovered since there is uncertainty about how long the pandemic may drag out and since there are still 7.6 million lost jobs. Also, there is uncertainty from high gasoline prices and the surge in inflation that is pushing up the prices of many goods and services.