William Riegel, Chief Investment Officer TIAA Investments
November 18, 2016
The dollar’s rise has been fueled by a number of factors, including expectations that a Trump administration’s plan for aggressive fiscal stimulus will lead to faster economic growth and higher inflation. This, in turn, may prompt the Fed to raise interest rates at a brisker pace than previously anticipated.
In overseas equity markets, Europe’s broad STOXX 600 Index rose 0.6% (in local terms) for the week, after posting its best one-week performance in four months. Buoyed by a weakening yen, Japan’s Nikkei 225 Index entered bull market territory on November 18, having risen 20% from its recent low in June.
Current updates to the week’s market results are available here.
Global bond markets continue to be driven by heightened inflation expectations. The yield on the bellwether 10-year U.S. Treasury, which moves in the opposite direction of its price, climbed to 2.34% on November 18, its highest level in more than a year, after beginning the week at 2.15%. In anticipation of Fed tightening, the 2-year note, which is highly sensitive to the outlook for Fed policy, closed the week at 1.07%, its highest mark since last December. Yields on European sovereign bonds, including German, Italian, and Spanish debt, also moved higher.Negative fund flows, along with rising interest rates, took a toll on non-Treasury “spread sectors.” For the week through November 17, losses ranged from -0.20% for high-yield corporate bonds to -0.81% for their investment-grade counterparts. Emerging-market debt remains the hardest hit fixed-income asset class post-election, although performance stabilized during the week.
This past week’s data releases featured additional signs of labor-market vigor, forecast-topping retail sales, and a multi-year best in the housing market.
The past week’s mostly upbeat data seemed to feed into the positive mood in equity markets since the election, as well as the likelihood of a Fed rate hike next month. (Indeed, market odds for Fed action in December exceed 90%.)
We believe the economy is merely reaccelerating toward 2% growth—the average annual GDP gain during this recovery. This return to trend follows a slowdown that lasted from the fourth quarter of last year through this summer, when GDP plodded along at a 1% clip. Some strong September data suggests that the government’s estimate of third-quarter GDP will be revised upward, from the original reading of 2.9% to around 3.1%.
Over the next few months, we expect a pickup in bond-market volatility as investors assess the potential outcomes of the new administration’s policies. Such periods of wide price swings may offer the opportunity to buy bonds at prices that are lower than today’s. However, fixed-income outflows may serve as a headwind, pressuring credit spreads.