Global stocks have staged a recovery over the past five weeks after an awful start to the year. The S&P 500 ended last Friday at 2050, up significantly compared to its low of 1829 on February 11. It’s now up 1% year to date. MSCI Emerging Market stock returns are up over 4% year to date, while the developed country MSCI EAFE Index is down over 2%. High Yield bonds have rallied, moving yield spreads vs. Treasuries from 850 basis points (bps) to 650 bps in less than a month!
The Federal Reserve kept interest rates on hold and cut its expectations for rate hikes this year to two rather than four at its FOMC meeting last week. The WSJ characterizes it as, “a nod to lingering risks to the economic outlook posed by soft global economic growth and financial-market volatility.”
The Fed’s famous “dot plot” of future rate hikes now shows short rates around 1% at the end of 2016, 2% at the end of 2017, and 3% at the end of 2018.
Reading between the lines, the Fed seems to be willing to take a bit more inflation risk to ensure a better economic recovery. They are more willing to be a step behind improving economic data than try to get ahead of it.
U.S. bond yields bottomed in February at 1.65% on the 10 year Treasury, but closed last Friday at 1.88%. Still, yields across the globe are at century lows.
The attached chart from J.P. Morgan shows that roughly 65% of government bonds worldwide now yield less than 1% and the portion of bond yields with negative rates is 30%.
Chart: J.P. Morgan Asset Management
Rates are low because of soft economic growth and low inflation, but most importantly because of ultra-easy central bank policies to encourage growth. Is it working or are central bankers “pushing on a string”?
During (and now 7 years after) the Great Recession central bankers pulled out all the stops with a hodgepodge of “unconventional policies”, which now include negative interest rate policies (NIRP). Savers are not happy!
Central bankers would argue that low/negative rates aren’t designed to punish savers, but rather stimulate borrowing – spending and investing. But economic growth has been sluggish, even with low rates.
In fact, savings have surprisingly gone up recently. Apparently, some savers (baby boomers, retirees, etc.) may feel the need to save more (spend less) when rates are low. Also, banks and insurers find it more difficult to be profitable in a low rate environment. There are “unintended consequences” of this NIRP/low rate strategy.
We think stocks have recovered as the economic data has been decent (it was never that bad) and oil has jumped to around $40, not because central banks have “come to the rescue” one more time.
In summary, the “panic attack” early in the year has given way to a “relief rally” and now most financial assets are bit higher than where we started the year.
Jeff Pantages, CFA®
Chief Investment Officer