Chart of the Week
Below, we highlight U.S. interest rates, which have shifted quite dramatically to start 2021. We comment in more detail in the Market and Economy Section:
COVID-19 Update
We appear to be in the feared 3rd wave of the virus with a persistent uptick in new cases over the past several weeks. The main cause of the uptick appears to be the prevalence of the various variants, which are more contagious than the original strain of the virus. The 7-day moving average of new cases, which tends to smooth out the daily ebbs and spikes, is now back around 450k globally from ~350k in mid-February.
Positive News
Put this in the category of – enormously positive news. Israel, which we have highlighted for the last couple of months as being well ahead of the vaccination curve, has seen a dramatic decline in its case count:
Israel has seen a similar sharp decline in its fatality rate to ~10/day from more than 60/day back in January. With more than 50% of the population now vaccinated, we can see the positive impact that mass vaccination can have, and the potential light at the end of the tunnel that exists for the rest of the world if we can get “needles into arms” over the next several months.
Negative News
As mentioned, as the various variants become the dominant strains of the virus, coupled with re-openings in many areas and an easing of mask mandates, we have seen new cases begin to rise in many countries, including Canada. With lockdowns beginning to get reinstated (France just announced a new 4-week lockdown) coupled with warmer weather and increased vaccinations, we are likely to see this latest surge peter out over the next few weeks, but the recent rise remains worrisome nonetheless.
.
Market & Economic Update
It was mostly a grind it out sort of week with most major indices down about 1%. The theme of higher interest rates continues to prevail, despite the best efforts of Fed Chairman Powell, who made it clear this week that he has no plans to raise interest rates any time soon, and from the sounds of it – may never raise interest rates again (we jest, but only sort of).
On this front, when long-term interest rates rise – as they have been for the past few months – it creates some pressure on Central Bankers to raise short-term interest rates. Why is that? The simple reason really comes down to two things:
Long-term interest rates are just the average of short-term rates. Put another way, if you buy a 10-year bond, it should be the same thing as buying a 1-year bond maturing in 1-year, and then another 1-year bond that you buy in 1-year that matures at the end of that year, and then another 1-year bond that you buy in 2-years that matures at the end of that year and so on and so on until you get to year 10. Believe it or not, there are something called bond futures that allow you to replicate the strategy just described and essentially synthetically replicate a 10-year bond. With 10-year rates now around 1.7% and short-term rates close to 0%, there has to be some of these 1-year bonds that are higher than 0% and, in fact, higher than 1.7% for the average to work out to 1.7% over the 10-years. This would require the Fed to raise rates at some point, otherwise, there is going to be a lot of money lost on these bond futures.
As long-term rates rise, the yield curve, which is just a reflection of what interest rates are for every possible time frame spanning 1-month to 30-years, becomes steeper and steeper. Currently, the difference between 10-year yields and 1-month yields is about 1.7% (because one-month yields are essentially 0%). This is fairly steep, especially when compared to where we were a year ago when the difference was ~0.5%. Steep yield curves are fine as they both help banks to make money (banks borrow at short-term rates and lend at long-term rates) and encourage banks to lend. But if the curve gets too steep, it can create problems – either long-term rates become too high that it discourages lending or banks relax their lending standards too much in order to capitalize on the spread.
We are not overly concerned right now about the rise in yields, as we would not be surprised to see them come back down over the next couple of years (although, they could be higher at certain times along the way). But rising rates are clearly part of the current market narrative, so we feel it is important to point it out.
Be Safe,
Matt & Ann-Marie