• A combination of factors, including inflation worries, contributed to a sharp and sudden steepening of the yield curve in February
  • Recent COVID trends and economic data have improved, fueling general market optimism
  • Some feel that the bond market is testing the Fed’s resolve, and to this point, Jerome Powell and his colleagues are holding firm to a more conservative (and dovish) outlook

February was another reminder of how quickly things can evolve in financial markets, and the magnitude and velocity of the rise in bond yields was painful for many market participants. If we take a step back, it was nearly one year ago when the first COVID-driven lockdown orders were initiated, which was a significant disinflationary event culminating with a record-shattering -31.4% GDP decline in the second quarter (annualized). With massive monetary and fiscal support, a reflation trade took hold of risk markets, and the S&P 500 generated a 68% return from the March 23, 2020 trough through the end of January.  In the early weeks of 2021, reflation has transitioned to outright inflation worries, which sent yields on 3-year and longer Treasuries soaring higher in a relatively short timeframe.

The catalysts for these inflation worries came from multiple fronts. As noted in last month’s commentary, there had been notable improvement in COVID cases and hospitalizations as January progressed, and that trend continued throughout February (see Exhibit 1). Adding to the more hopeful outlook was a Wall Street Journal Op-ed by Johns Hopkins professor Dr. Marty Makary on February 18 that suggested herd immunity might be reached as early as April.  In coming up with this prediction, Dr. Makary said that testing has only been capturing 10-25% of infections, inferring that “about 55%” of Americans could already have natural immunity. Based on the current trajectory of cases and projections for vaccine distribution, he opined that “COVID will be mostly gone by April.” This is clearly just Dr. Makary’s informed opinion, but it only fed the inflation narrative more.

On the economic data front, the January retail sales report released on February 17 was a scorcher. The control group, which is used in the GDP calculation, rose 6% versus the prior month, 5 points more than expected (Bloomberg median survey). January sales figures were almost certainly boosted by the $600 stimulus checks sent out at the beginning of the month. Economists responded by increasing consumption and GDP forecasts for Q1, and all the while, House Democrats continued to push forward with the White House’s $1.9 trillion COVID-relief package, despite growing debate as to the size of the package (and how much goes beyond actual COVID relief). The bill still must be negotiated in the Senate, but at the same time, talks of a large infrastructure spending package by year-end surfaced in recent weeks. Added together, all these factors stoked the inflation narrative in financial markets, not to mention the expectation of an unwinding of the glut of personal savings built up over the last year as the economy normalizes.

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