Written by: Sid Mohapatra
Risk markets leapt to new heights in the last week’s trading sessions as market participants continue to price in optimism over the prospects of a renewed economic recovery fuels the rally. Further, a relatively higher inflation report along with retracement in interest rates caused the equity markets to bounce back this week. Finally, the US Senate gave green light to the American Rescue Plan (ARP) with President Biden signing the pandemic-relief bill this week.
Despite a broader economic recovery taking shape, significant portions of the economy, as well as the labour force, remain on the sidelines as a result of lockdowns. This reflects in the GDP numbers which shows that the swift economic recovery is uneven and remains fragmented. The implications of this are evident in the market expectations of the future pace of fiscal stimulus to be very limited and potentially setting up the risk markets for a steep decline with any adverse news as a catalyst. However, on a less speculative tone, this fiscal stimulus has three main implications:
- Risk of overheating the economy: If this stimulus overheats the economy with a sharp increase in economic activity will lead the inflation fear-mongers to appear and lift nominal yields causing the Fed to grudgingly intervene.
- More Government Debt: A clear relationship between government stimulus spending and increasing treasury auction sizes (both coupon and bill supply) exists. The quarter-end reporting for dealers might impair the ability to take down the upcoming supply of these risk-free bonds.
- Drop-in future expectations of fiscal stimulus: As the markets act on buying the rumour and selling the news, the fact that there is no more planned stimulus in the works puts little wind behind the equity markets to rally on that front.
The TSX closed at 18,851 gaining a significant 2.6% while posting a strong 8.1% on a YTD basis. In the US, S&P 500 was up 2.6% and up nearly 5% on a yearly basis. US Ten year Treasury yields hovered around 1.58% and up 10 bps from the last week but not testing the highs set in the last month.