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The most important development of the past week was the outsized move in 10-year Treasury yields. Although marketplace consensus believes that long-term interest rates are set to stay lower for longer, five factors suggest higher long-term rates could be ahead, according to Mike Wilson from Morgan Stanley.

Key quotes

“The policy response to this recession is different than what we got after the Great Financial Crisis. While monetary policy support is similar, the scope and size are much greater. More importantly, it has been accompanied by equally large fiscal policy support that was absent after the Great Financial Crisis, and it’s directed right at consumer spending rather than the banks. Therefore, the Fed’s money printing this time is going directly into the real economy, and that’s potentially inflationary.”

“The next fiscal stimulus is likely to be bigger once it’s passed. Despite the uncertainty around the negotiations in Congress, we think the stimulus package ultimately will be passed and due to the delay, is likely to end up being bigger than originally proposed. This may come as a surprise to the bond market, particularly if it starts to realize such spending as structural rather than cyclical.”

“Longer maturity parts of the bond market may already be having digestion problems with the current supply. Last week’s 30-year auction went poorly, with a weak bid to cover ratio and a large tail.”

“The Fed is likely to announce an average inflation targeting scheme over the next few weeks. That should mark peak fed dovishness unless they decide to move to negative rates, something we think is very unlikely. Peak Fed could mean a trough for longer-term interest rates.”

“Stocks and commodity prices are leading indicators. Our cyclical/defensive stock ratios suggest long-term interest rates are significantly underpriced. Meanwhile, both copper and gold have risen sharply over the past few months in anticipation of rising inflation, which also suggests long-term rates are too low.”