Headlines are bad advisors

 In Articles

Inflation rises, interest rates fall

“Inflation Is Here. What Now?”, “US Inflation is Highest in 13 Years as Prices Surge”, “Is It Time To Panic About Inflation?”, “Is Inflation Real Enough to Take Seriously?”, just a few headlines from the New York Times and the Wall Street Journal in recent months. Judging by these reports, interest rates should make quite an upward move. Since the beginning of April, however, the 10-year interest rate on U.S. government bonds fell from 1.75 percent to, at one point, even 1.37 percent. Why is the financial world so afraid of inflation if the bond market is not contracting?

Stock markets anticipate the news

This is yet another great example that investing based on headlines is doomed to fail. After all, the media report on things that have already happened – that is their job, after all. Investors, however, have to assess what is going to happen. For example, the rise in 10-year yields from the summer of 2020 from the bottom level of 0.50 percent was evidence that markets had long priced in the recovery from the pandemic. As well as any resulting price increases. In early April, this so-called recovery rally peaked at a 10-year interest rate of 1.75 percent. Since then, interest rates have been falling again. For the record, the S&P 500 index has also been moving mostly sideways since mid-April.

Notable reaction

Now, the reaction to the Federal Reserve’s latest statements, in particular, was, at first glance, rather contradictory. First, Powell came out with the announcement that the central bank seems to be taking inflation more seriously after all than initially estimated. Then fellow Fed member Bullard did it all over again by stating that interest rates might be raised sooner. The markets reacted surprisingly. The 10-year interest rate did not rise, but fell. However, 2-year yields – more sensitive to the central bank’s monetary policy – did rise quite a bit. So while the world seems to be in the throes of a spectacularly recovering economy, the yield curve is flattening. 

Commodities are falling too

A flatter yield curve may indicate a decline in economic growth. Weren’t the markets’ expectations too high since the beginning of November last year? For a few weeks, the prices of most commodities have fallen. In some cases, sharply. Copper, for example, fell 13 percent in a good month. Wood, the symbol of infrastructure investment and economic recovery, even fell by more than 40 percent. The Bloomberg Commodity Index lost about five percent. However, this was partly due to the fact that the price of oil held up well. Are these signs that the peak of the economic recovery is already behind us?

Is the economy cooling again?

In the United States, figures on building permits issued and houses under construction have been pointing to a possible cooling housing market for some months. Applications for new unemployment benefits also point to a weaker labor market. The recently published disappointment in retail sales also underlines the reticence of American consumers. Of course, these figures are not evidence of an impending recession. However, the economic recovery could perhaps be a little less euphoric than anticipated on the stock markets over the past six months.

Yields, not headlines

It could also be that the fear of inflation has already passed its peak. And that the markets need to worry less about a Federal Reserve that will apply the brakes sooner than initially expected. In an economy where debt has risen to historic proportions – and continues to grow at a rapid pace – the central bank has little room to raise interest rates anyway. For the time being, investors are best focused on hard facts, such as interest rates. And not on the many opinions they are inundated with. “Look for yields, not headlines”.

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