The 10-year treasury note punches through 1%… what it means for stocks … what it also suggests about inflation … the metric to begin watching today
On Wednesday, a mob storming the Capitol building might have distracted you from something important that happened in the fixed-income market …
The yield on the benchmark 10-year U.S. Treasury note rose above 1% for the first time since March.
As I write Friday morning, it’s even higher, at 1.102%.
So, why is this significant?
Well, let’s make sure we’re all on the same page …
***The “10-year” is a key global benchmark interest rate
As it goes, so goes countless other interest rates (one of the most notable is your mortgage rate).
The 10-year is also viewed as a sign of investor sentiment about the economy.
When investors feel confident, the price of the 10-year drops and its yield rises (bond prices and yields are inversely correlated). This reflects investors’ belief that they can find higher-returning investments elsewhere without those other investments being too risky.
So, the 10-year yield pushing up through 1% reveals investors’ willingness to flee the relative safety of the 10-year, venturing out in a quest for higher returns.
But there’s something else this “breaking 1%” means. Traders are expecting a market-dynamic we haven’t seen in a long, long time …
***The relationship between the 10-year, the Georgia senate election, government spending, and inflation
In their Wednesday update of Strategic Trader, our technical experts, John Jagerson and Wade Hansen, connected the 10-year yield with the Georgia senate race and inflation:
The TNX broke above 1% for the first time since March 20, 2020, this (Wednesday) morning.
This is huge. Here’s why.
Treasury yields have been depressed for nearly a year because bond traders have been willing to accept virtually no return on their investments as the Federal Reserve has cut short-term interest rates to zero and the coronavirus pandemic stifled economic growth and inflation.
However, if Democrats end up controlling not only the White House but also both houses of Congress, that could all change.
For the past year, Fed Chair Jerome Powell has been asking for more fiscal stimulus to bolster the monetary stimulus the Fed has been providing to try and stabilize the U.S. economy, but Republicans in the Senate have been unwilling to give it.
But if Democrats take control of the Senate, they have said they will be more than willing to provide additional spending.
Additional spending would likely lead to increased economic growth, which in turn would likely lead to an increase in inflation.
Bond traders are starting to price in this possibility by demanding a higher yield on their Treasury investments to compensate for the increased inflation risk.
As we know now, Georgia Democrats, Jon Ossoff and Raphael Warnock did, in fact, win their U.S. Senate races. This gives Democrats the complete control John and Wade reference above.
***And as expected, more spending is immediately on the docket
Senate Minority Leader Chuck Schumer (D-N.Y.) said during a press briefing Wednesday that passing legislation to increase the amount of direct payments in the most recent stimulus bill from $600 to $2,000 is “one of the first things I want to do” when the two new Democratic senators from Georgia have been seated and Democrats take control of the chamber.
Keep in mind, if this happens it will add another $463.8 billion onto the $900 billion stimulus bill recently signed by President Trump.
Now, some inflation would be good for stocks. Back to John and Wade to explain:
This is all good news for the stock market.
Traders have been looking for an excuse to continue pushing stocks higher, and this may be it.
Additional fiscal stimulus and stronger economic growth should help boost corporate revenues and earnings in 2021.
However, inflation is a bit like fire — it’s very hard to control once it gets going. And on that note, here’s something we need to keep an eye on …
***Watch what happens with the velocity of money
Back around 2008/2009, due to the financial crisis, the U.S. began printing trillions of new dollars, as you can see below …
Yet, this avalanche of new money didn’t result in significant, sustained inflation as many feared.
Short answer — because the Fed’s new dollars boosted the monetary base but not the money supply.
To put it simply, even though the Fed created trillions of new dollars (the monetary base), most of it remained parked in the banks, shoring up destroyed balance sheets.
In fact, only a fraction of it actually made its way into the U.S. economy, which meant it didn’t increase the money supply in a significant way.
This meant dollars weren’t swirling all about — from wallets, to cash registers, to balance sheets, to paychecks, back to wallets …
But if money isn’t actually cycling through the economy, you can’t really have inflation even if there are more dollars in existence.
We can see this lack of money-movement by looking at what’s called “the velocity of money.”
Below is a chart of the Velocity of M2 Money Stock from the Federal Reserve Bank of St. Louis, from 2010 through 2015.
As you can see, velocity was slowing this entire time, which paralleled the Fed’s failure to spark the inflation it wanted.
Now, let’s return to today …
As you’re aware, the U.S. government and the Fed have been back it, printing trillions of new dollars in 2020. In fact, one estimate suggests that 23.6% of all the U.S. dollars created — ever — were created last year alone.
Yet, similar to the aftermath of 2008/2009, we didn’t see an uptick in the velocity of money in 2020.
This time, it was because the money either funneled into bank accounts — U.S. savings rates hit a record 33% as the coronavirus led Americans to stockpile their cash …
Or the money went to paying delinquent rents, overdue bills, or just basic staples needed to survive.
Either way, this money hasn’t been swirling all about a healthy economy.
With so much money being printed, and parts of the U.S. economy trying to re-open, we’re finally seeing an uptick in the velocity of money for the first time in years.
See for yourself. Below, we look at the same Velocity of M2 Money Stock chart, though updated to the present day.
Be sure to notice how the chart hasn’t just turned sideways. It’s a sudden, sharp, upward reversal …
***This isn’t bad news
The Fed has been trying to jumpstart inflation (unsuccessfully) for a long, long time.
However, we need to watch what happens to this velocity of money come this spring and summer after enough vaccinations enable our economy to re-open on a wider scale.
Legendary trader, Paul Tudor Jones, recently commented on what he expects:
The vaccine’s going to bring us back. We’re going to have an incredible growth rebound.
I have four kids in their 20s. And, it’s like a horse at the beginning of a race. They’re so ready to get to see their friends, to get to restaurants, to vacation. They’re just ready to get out and go crazy, like I think everyone else in the world.
When the world re-opens, and consumers “go crazy,” this time armed with some of the trillions from the Fed, what do you think will happen with the velocity of money?
On this note, I’ll add that Americans’ disposable income tallied $15.5 trillion in November. That’s up from $15 trillion the year before.
So, with all this extra cash finally hitting the actual economy, what do you anticipate will happen with inflation?
As noted earlier, some inflation will be good for the economy and the stock market. The issue is simply, can we control it once we’ve started it? Anyone who lived through the 1970s probably has an opinion on that answer …
But for now, some inflation, even moderate inflation, will act as a tailwind for stocks.
So, going forward, keep your eyes on the yield of the 10-year, as well as what happens with the velocity of money. They’ll tip us off about where we’re headed with inflation.
In the meantime, the market is in euphoria mode, so let’s make money while we can.
Have a good evening,