Market Strength Driven by Policy, not Economics

Posted on September 21st, 2020

The recovery of U.S. stocks from the depths of the market turmoil in March, when the pandemic became official, has been unprecedented. Equity values returned to where they were before the pandemic in August. The rebound in equity indices has been one of the strongest in nearly 90 years, propelling indices to new highs this past month.

Technology stocks have outpaced other sectors, with the widest gap in performance in 30 years. Substantial monetary and fiscal stimulus over the past five months helped elevate stocks in addition to better than expected earnings for various sectors and industries. Some analysts believe that it has become a policy driven market, rather than economic driven, meaning that interest rate policy and tax policies are becoming more consequential.

Rates rose slightly in mid-August, following a weaker than expected auction for U.S. government bonds. The yield on the 10-year treasury rose from 0.55 in early August to 0.71 in mid-August, representing nearly a 30% jump within two weeks. The rapid rise in rates also lifted mortgage rates and other consumer lending rates, which had already fallen substantially since late March.

The Federal Reserve communicated an extended period of near zero short-term rates over the next five years as it expects inflation to be mild. The announcement sent longer term bond yields higher versus shorter term bond maturities.

Over $1 trillion of mortgage bonds have been purchased by the Federal Reserve since March of this year. The ambitious buying spree is meant to help sustain the housing market as jobs and incomes have faltered during the pandemic. Lower mortgage rates are expected to remain in place encouraging homeowners to refinance and buyers to purchase.

Sources: Bloomberg, Reuters, Federal Reserve, U.S. Treasury