Stocks Edge Back From Records As US Yields Slide

Yield drop catches markets by surprise

Much of this week was spent trying to decipher the cause of the recent plunge in Treasury yields. Various narratives have been offered but no consensus thesis has emerged. Among the factors cited are increasing concerns over the spread of the Delta variant of the coronavirus, signs that global growth and inflation may have peaked near term, fears of a slowdown in China’s credit growth, and a flatter US yield curve due to renewed US Federal Reserve inflation vigilance. Many expect a choppy ride for rates market over the next several months but anticipate higher yields over the medium term. Near-term, investors are grappling with the implications of lower yields. While they tend to be supportive of risk assets as they are forced to seek higher-yielding assets, lower yields may be a signal that the global recovery may not proceed as smoothly as expected.

ECB adopts new policy framework

The European Central Bank adopted a new, more flexible policy framework this week that echoes a similar structure implemented by the Fed around a year ago. The ECB shifted its inflation target from close to, but below, 2% to 2% while allowing for periods of overshoot. In contrast, The Fed aims for inflation to average 2% over time, letting inflation run above target for some time to offset periods when it falls below target. The ECB also announced it will  move to incorporate owner-occupied housing costs into inflation calculations and support efforts to tackle climate change via its asset purchase programs and other operations. As a result of the strategy shift, investors expect the central bank to maintain its exceptionally loose policy stance for even longer.

China adds liquidity

The People’s Bank of China today unexpectedly lowered its reserve requirement ratio on banks by 0.5%, freeing up an estimated $150 billion in long-term liquidity. Analysts had expected a more narrowly focused move targeting liquidity for smaller enterprises. China spent the early part of 2021 curbing credit growth, but fears of slowing growth have prompted a reversal. Government efforts to cool a rise in commodity markets appeared to bear fruit as producer prices slipped from a 13-year high in June.

Biden order targets anticompetitive practices

US President Joe Biden will sign an executive order today promoting increased US economic competition. The order contains 72 initiatives targeting practices the administration says have driven up prices, disadvantaged workers and stunted economic growth. One focus of the order is increased antitrust scrutiny of the technology sector; pharmaceutical pricing is another.  

FOMC minutes set stage for earlier taper

The minutes of the June meeting of the Fed’s Federal Open Market Committee showed that “various”  (an undefined term in the closely watched world of Fedspeak) members said they expect the conditions for beginning to taper asset purchases “to be met somewhat earlier than had been anticipated.” Market observers expect the Fed to begin dialing back bond buying in late-2021 or early-2022. The minutes show that inflation has run hotter than members expected but that it has been concentrated largely in sectors impacted by the economic reopening. The FOMC still expects inflation pressures to be transitory, though a substantial majority of members now see inflation risks as skewed to the upside. Since the committee’s meeting in mid-June, the market has come to expect early rate hikes, but fewer of them than they did before the meeting.