Prospect of Higher Rates Drives Markets
With the possibility of a December hike in U.S. interest rates back on the table, bond yields rose last week (as prices fell), and investors continued to favor stocks, despite already high valuations. The yield on the 10-year Treasury rose from 2.09% to 2.15%, and two-year yields advanced as well. Meanwhile, stocks posted modest gains. The Dow Jones Industrial Average inched up 0.09% to close the week at 17,663, the S&P 500 Index was up 0.19% to 2,079 and the tech-heavy Nasdaq Composite Index advanced 0.44% to 5,053.
Although interest rates are little changed year-to-date and likely to remain range bound, the renewed prospect for higher rates in the U.S. and the opposite trend elsewhere in the world is once again pushing the dollar higher. However, a continued strong dollar would represent a headwind for U.S. inflation, precious metals and U.S. company earnings.
Reacting to the Fed
The Federal Reserve (Fed) issued a statement last week that acknowledged continuing concerns around international developments, but also left the door open to a December rate hike. The U.S. central bank’s decision to pursue that path will hinge on the next several weeks of data. Still, investors were somewhat surprised by the Fed’s tone. The odds of a December hike increased from 35% to 50%, two-year yields rose and the dollar advanced.
To be clear, the recent rebound in the dollar is being driven as much by events in Frankfurt and Stockholm as by the Fed. Most other central banks are racing in the opposite direction of the Fed. The latest example was the Swedish Riksbank, which expanded its bond-purchase program for the fourth time since February. While U.S. two-year yields are paltry at less than 1%, they look tantalizing relative to Europe; two-year yields are negative in France, Germany, the Netherlands and Switzerland.
Given the renewed divergence in global interest rates, it should come as no surprise that the dollar is once again rallying, hitting a two-month high last week before surrendering some of its gains on Friday. With the dollar appreciating and inflation expectations remaining moribund, there is considerably less demand for inflation hedges such as gold and silver, with both declining last week.