The S&P 500 put in a mixed performance this week: hitting a new all-time high Wednesday after the Fed’s FOMC statement but then selling off over the latter half of the week, ending the week down 0.8%. Long-term Treasury yields continued to rise, hitting their highest yields in a year, now surpassing pre-pandemic levels. This week, we also got retail spending numbers for February, and updated economic projections and a statement on monetary policy from the Fed, in addition to the weekly update on the labor market and national mortgage rates. On the political front, we now know the Biden administration’s next priority: infrastructure spending and higher taxes. Read on for more of the market weekly update, and you can find all the previous Monday Market Update’s here. You can now also get the weekly headline highlights on Finance Explained, my new podcast.
Monday’s Market Weekly Update for 03.22.2021
It was a bit of a mixed bag for the market last week. The S&P 500 hit a new all-time high on Wednesday immediately following the Fed’s FOMC statement, but sold off on Thursday and Friday after a weaker than expected jobless claims report. It fininshed down -0.8% for the week, +2.7% month-to-date, and 4.2% year-to-date, as long-term Treasury yields continued to rise and inflation concerns persisted. The 10-year and 30-year treasury bond yields are now up over 0.80% each since the start of the year, an 89% and 49% increase in yield in less than 3 months.
How does this impact you? It increases the interest rates you pay. Last week, we saw 30-year mortgage rates increase for the 5th consecutive week and now over 3%, still near historic lows, but the highest they have been since last summer. We are also seeing rising interest rates continuing to drive some investment rotation in the market – with last year’s high flying, tech-heavy Nasdaq now down -0.3% for the year and growth stocks down -1.0% year-to-date, while Small Cap stocks are up 16% and value stocks are up more than 10%.
Where are we seeing inflation expectations? A major inflation indicator is the 10 Year Treasury to TIPS spread. Ten-year TIPS yields are currently negative, meaning current actual long-term interest rates are lower than expected inflation. The Treasury spread to TIPS widened again this week, ending the week at 2.29%. The last time the spread was this high was back in 2018, when the Fed was consistently raising the Fed Funds Rate, to offset inflation concerns. This spread historically has predicted inflation growth about a quarter ahead of time, and at current levels, estimates inflation of about 2% for the coming quarter (vs. latest level for February of 1.7%).
It should be noted the Fed’s own estimates for 2021 inflation now sit at 2.4%.
Last Week in the Markets
A significant decline in energy stocks, as well as weak performance in financials and technology, drove down the S&P 500 Thursday and Friday, from the new high it hit Wendnesday, ending the week down 0.8% from the week prior, as oil prices ended the week down -6.3%. Long-term interest rates continue to increase, driving bond prices down, with long-term Treasury bond indices now down 14.5% year-to-date. And inflation concerns, which have driven commodity prices year-to-date, softened a bit as oil prices fell this week, now up 14.5% YTD.
We continue to see recovery hopes and inflation concerns drive outperformance of cyclical, small cap and value stocks vs. tech stocks, which are basically flat year-to-date. Small cap stocks gave back some of the prior week’s rally, losing -2.7% for the week, but still far outpacing all other indices year-to-date.
In the bond market, you can see a similar outperformance of higher risk securities, as investors seek higher sources of return. High Yield bonds, with lower credit and higher interest rates, have significantly outperformed Investment Grade and Treasury bonds year to date, though all bond indices are now down year-to-date, as rising yields drive prices down. For more on the inverse relationship between bond yields and bond prices, see 10+ Different Types of Investments under How Bonds Work.
The rise in the longer-term end of the current yield curve since the start of the year has driven the price of bonds down significantly. Longer-term interest rates continue to rise, spurred by the hopes of the economic recovery, as well as inflation concerns and the significant coming issuance of Treasury bonds, necessary to fund the $1.9 trillion stimulus package. The rates on 30-Year Treasuries now surpass pre-pandemic levels at the end of 2019. This steeply upward sloping yield curve is representative of a more normal, growing economic environment. Compare it to the yield curve last March, an inverted curve, when long-term Treasury rates hitting their lowest levels ever, which is predictive of a recessionary environment.
Concerns over inflation, and the rapid growth in the money supply, have fueled the rise in more speculative investments, like commodities and cryptocurrencies, like Bitcoin. Want to know more about what’s driving inflation concerns? Check out this post on Higher Inflation. Bitcoin continued its rally this week, following the Fed’s continued commitment to accomodative monetary policy.
The Economic Weekly Market News
This week’s major economic releases included:
- Tuesday: Advanced Retail Sales
- Wednesday: FOMC Statement & Press Conference
- Thursday: Weekly Jobless Claims & National Mortgage Rates
Advanced Retail Sales for February
The US Census Bureau releases an estimate of US retail and food services sales each month. Why do these matter? They give us the first indication each month of how consumer spending is doing, and recall that consumer spending represents 70% of our overall economy.
Economists predicted retail sales to be down slightly, given the bad winter storm that shutdown states like Texas for nearly a week last month, as well as the difficult comparison to January, which had the benefit of stimulus check-fueled spending. But they were worse than most predicted. Down -3.0% vs. January. If you zoom in at the most recent data, you can see how stimulus checks boosted January spending above the long-term trendline, and February was just coming back towards reality.
Sales were flat to down in all major categories vs. January. Overall, on a year over year comparison, all major categories have seen solidy growth… except restaurants, which hardest hit by the quarantine restrictions, have seen sales down 17% year over year.
It will be extremely interesting to track retail sales over the coming months given the largest round of stimulus to date has now been sent. The US issued more than 90 million checks worth a total of $242 billion over the last week. That in combination with accelerating vaccination rates, and many states easing back health restrictions, should lead to a healthy recovery in retail spending as we move forward in 2021.
So, who is the FOMC and what do the meet about? The Federal Open Market Committee (“FOMC”) meets 8 times a year to determine the open market operations of the Federal Reserve. The FOMC consists of twelve members – seven members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of Nyew York, and four of the remaining eleven Reserve Bank presidents, who rotate terms annually. (There are twelve Federal Reserve Banks: New York, Boston, Philadelphia, Richmond, Cleveland, Chicago, Atlanta, St. Louis, Dallas, Minneapolis, Kansas City, and San Francisco.)
They meet to review current economic and financial conditions, and determine what is appropriate monetary policy given those conditions. Following each meeting, the Fed releases a formal statement and the Fed Chairman holds a press conference. The markets follow the formal statement extremely closely, not only for any change in the exact Fed Funds target rate and open market purchase activity, but also for any minor changes in wording that could indicate future actions. There was no change to monetary policy out of this meeting.
What are open market operations? It means the Federal Reserve buying (or selling) primarily US Treasury securities on the open market, just like any other investor, but in order to regulate the money supply. The Fed buys Treasuries, and currenly mortgage-backed securities too, to increase the supply of money, and can sell them in the future to reduce the supply of money. The overall objective is to manipulate short-term interest rates consistent with monetary policy and increase or decrease the money supply to keep markets and prices stable. The Fed is currently buying $120 billion worth of Treasuries and MBS monthly, expanding its balance sheet and the money supply, which has grown more in the last year than ever before.
During the March, June, September and December FOMC meetings, the members also make predictions for the economy. Specifically, they all give their predictions for GDP growth, unemployment, PCE growth (inflation), as well as what they believe future Federal funds rate targets will be. The Fed publishes these predictions as a summary, but also as individual dots, so you can see exactly where every prediction by each member fell.
While there was no change to monetary policy out of this meeting, March 2021 projections show far stronger growth expectations for 2021, near normal levels of unemployment by the end of 2021, as well as expectations for 2.4% inflation for the year. You can see how their projections have changed at each quarterly meeting since last June. Given these improving expectations, you can also see how their votes for when to begin raising interest rates changed as well. Three more members, now up to 4 votes, expect rates to rise next year, and 7 members, up 2 votes from December, expect to see higher rates by 2023.
The Fed is holding tightly to its position of accomodative monetary policy given the current weakness in the labor market. They also believe inflation expectations to be transitory – temporary or for a brief period of time – and not persistent. What are investors worried about here? With short-term rates continuing to remain at essentially zero, should the economic recovery falter at all in the coming few years, particularly if inflation ends up being more permanent, the Fed will have very limited tools at their disposal to effectively stimuluate the economy. Lowering rates below zero – as has been done in the Euro zone – literally means you get charged for keeping money in your savings account. It’s NOT very popular policy. And adding to the money supply for even more open market purchases, further fuels inflation.
Weekly Jobless Claims
I continue to closely watch the labor market for signs of improvement, as it has experienced the most negative impact in the economy, and its recovery is most critical to a full economic recovery for everyone. On Thursday, weekly jobless claims for the week ending 3/13 increased to 770,000 from the previous week’s revised level of 725,000. Economists had expected them to improve. This remains extremely elevated relative to pre-pandemic and even past recession highs. We have had an entire year of weekly claims higher than the highest weekly claims in any prior recession.
Total insured unemployment, under regular state programs, is down to 4.1 million people, an insured unemployment rate of 3.0%. However, this remains only a fraction of those covered under the expanded pandemic and emergency programs at both the state and federal level.
Total insured unemployment under these programs for the week ending 2/27 (this comes at a longer lag) is far greater – 18.2 million, this week down by nearly 2 million claims vs. the week prior. This total has bounced around a lot in recent weeks. I’m not entirely sure why – if it’s due to the timing of benefits expiring before being extended or something else. The PEUC, or Pandemic Emergency Unemployment Claims, where we see the biggest decline in continued claims, is an extension of unemployment benefits for up to 24 weeks after someone has exhausted their state benefits. These were previously slated to expire last week, but under the American Rescue Plan Act officially passed into law two weeks ago, the expanded Federal benefits programs are now extended to the end of August, so we will see if they ends some of the volatility around those.
Big picture: this is really what insured unemployment looks like – and you can see how continuing claims show essentially a stalled, if not worsening, labor market based on those collecting unemployment insurance.
Weekly Mortgage Rates
I have started watching mortgage rates more closely as long-term interest rates have started rising. While mortgage rates still remain at near historically low levels, they are rising weekly as market rates rise more broadly.
Freddie Mac publishes the results from its Primary Mortgage Market Survey every Thursday, giving the weekly US average for 30 Year Mortgage rates. As of 3/18/2021, the average 30-year rate was 3.09% with 0.7 points, now up +0.42% since the start of the year, a 16% rate increase.
Calling All Realtors & Mortgage Experts…
I will be hosting a second LIVE Q&A this Spring and would love for you to share your expertise and what you are seeing in your local markets as the Spring selling season gets underway.
FRIDAY, 5/14 – 9:30AM ET
If you are able to join, please sign up here!
The Political Weekly Market News
On the political front with regards to family finances, now that the major stimulus bill has passed into law, the Biden Administration is turning to other campaign promises: infrastructure spending and raising taxes to pay for it.
The two major headline components of Biden’s higher tax plan is raising income taxes on households earning more than $400,000 a year, and increasing the corporate tax rate from 21% to 28%.
There is no official bill for this in Congress yet, and pulling off the largest tax increase in decades in the midst of an early economic recovery will be no easy feat. But here’s a brief overview of what is proposed, as well as the projected economic impact from two different tax think tanks, one progressive and one conservative.
First, let’s talk corporate taxes – the increase in the corporate tax rate from 21% to 28% is projected to drive one of the largest increases in federal tax revenues of all the changes proposed. Varying estimates predict it would raise from $750 billion to over $1 trillion in the next 10 years. Pre-2018, the US had the highest corporate tax rates in the developed world. If domestically, corporate taxes are higher than in other countries, it creates an incentive for corporations to locate their businesses – and thus jobs – elsewhere.
President Biden campaigned on, and has reiterated his commitment to, increasing the corporate tax rate. And while he doesn’t plan on returning it to 35%, he wants to increase it to 28%, returning us to, while no longer the top, among the highest corporate rates in the developed world.
Now, what about income taxes… the Biden administration this week had to address the fact that his campaign promise – to only raise taxes on those making over $400,000 – applies to households, not individuals. He proposes rolling back the “Trump Tax Cuts” for just the top tax bracket, while also increasing the long-term capital gains rate, for taxes paid on investment gains from investments held more than a year, to normal income tax rates for those with income over $1 million.
But the biggest federal tax revenue raiser – a payroll tax hike for those making more than $400,000. Currently, the payroll tax rate for Social Security is 12.4%, with half paid by you as an employee and half paid by your employer. It also has a wage base limit – for 2020, you only paid in on the first $137,700 of income. This base is $142,800 for 2021. President Biden’s proposal would reinstate it on earnings over $400,000. Based on household income data, this essentially applies to the top 1% of households, or approximately 1.2 million households.
His proposal also includes additional tax hikes for estate taxes, limits on both business and personal income tax deductions, as well as credits that offset some of these increases. It should be noted that no overall program has officially been unveiled, and so far is all just based on what he campaigned on and has affirmed post election but most analysts estimate an increase in federal tax revenues of $2-4 trillion over the next 10 years.
Now, you may look at this and say, that only applies to businesses and the rich. It won’t impact me. However, it is important to realize that when you tax something it creates changes in behavior that have ripple effects through the economy. Raising taxes on investment is likely to reduce investment. Raising taxes on businesses is likely to reduce jobs, creating unemployment. And both of these projections, one from the conservative-leaning Tax Foundation and one from the progressive-leaning Tax Policy Center, predict a reduction in GDP resulting from the plan over the next decade. The Tax Policy Center talks to reduced labor supply, but doesn’t quantify it, while the Tax Foundation estimates it would produce more than 0.5 million fewer jobs.
I’ll be writing more about the impact and implications of higher taxes later this week, to address how tax increases impact employment and GDP.
The Virus Update
The biggest update here is The Covid Tracking Project, which came together to do an amazing job tracking the data of the pandemic before government agencies were doing it effectively, officially stopped their updates March 7. I have now shifted the data source here to the CDC’s Covid Data Tracker – the good news, the data is very similar, if not as user-friendly and easy to navigate.
The other even better news? The addition of the J&J vaccine to the vaccine rollout is accelerating both availability, as well as those fully vaccinated, as it only requires one dose. Over 43 million people are now fully vaccinated, up 23% in the last week!
For going on 2+ months now, we continue to see numbers head in the right direction. New cases continue to trend down. We see continued declines in daily deaths. Declines are attributed to a combination of subsiding from the post-holiday spike, as well as the continued aggressive rollout of the vaccine, which began in mid-December.
We also continue to see progress in the vaccine rollout. We saw a 17.5% increase in vaccines distributed and a 20% increase in vaccines administered last week relative to the week prior, and are now vaccinating more than 2 million people daily. Note that vaccination data continues to be updated for up to a week, so expect the most recent week’s data to increase. So far, over 43 million people are now fully vaccinated, representing 13% of the population. Many experts believe we need to get to 65-80% vaccinated to achieve herd immunity, which would allow life to resume with some level of normalcy.
The Week Ahead
It’s a big week for economic data:
- Monday: Existing Home Sales for February
- Tuesday: New Home Sales for February
- Thursday: Weekly Jobless Claims & Mortgage Rates
- Friday: Personal Consumer Expenditures & PCE Price Index (Fed’s inflation measure!)
For More Information…
For a more detailed history of all the metics shared, check out When Will the Economy Recover – updated monthly, which gives a more detailed overview of market and economic indicators, as well as their historical context.
Questions? Feel free to leave them in the comments below, in the weekly question box in my Instagram stories, or now you can leave me voice messages for the Finance Explained podcast too!