Volatility Continues as Fiscal Stimulus Package Takes Shape

Though rising yields may be indicative of an economic recovery, market volatility and inflationary fear could produce future hurdles.

Though the shortest month, February was long on optimism. Vaccinations increased in pace, and market consensus seems to be coalescing more around the idea of a strong economic rebound this year. Continuing accommodative policy from the Federal Reserve (the Fed) and the expectation that Washington will produce another round of fiscal stimulus play into the reaction we’ve seen in the market.

Through that, the equity market gained 2.8% with seven of 11 sectors in the green. Volatility was seen late in the month as the speed of rising rates caught the market off guard. The yield on the 10-year Treasury reached 1.46%, the highest level in a year, before settling back to end the month at 1.39% – but rising yields can be indicative of an economic recovery.

There has been, however, a turn to inflationary fears in some corners – which may be contributing to the rising long-term bond yields. One should always be cautious of too much market optimism, but Raymond James Chief Economist Scott Brown offers a counter argument to the simmering discussion.

“Within its revised monetary policy framework, the Federal Reserve will shoot for a period of inflation above 2% – following a period below 2%, as we’re seeing now – but the central bank remains firmly committed to its long-term goal of 2% inflation,” Brown said.

In the short term, Brown said he expects to see inflation rise to about 3% on a year-over-year basis, “but that simply reflects a rebound in prices that were held down during the lockdowns a year ago.” Market expectations of inflation for the next five years have risen rise to about 2.3%, but inflation is expected to settle to the Fed’s 2% goal in the five years to follow.

The reported unemployment rate of 6.3% understates the weakness in labor market conditions. Federal Reserve Chair Jerome Powell noted that the rate would be closer to 10%, adjusting for the decrease in labor force participation and classification issues, leaving the central bank “a long way” from achieving its goals. On a positive note, consumer spending is up after a lackluster holiday season, and manufacturing activity continues to improve, and in Europe, there is a comparable rising optimism, for similar reasons.