After several months of tranquility, volatility has definitely returned to both the bond and equity markets. All major U.S. indices traded down near or above 2% on Friday after a choppy week of trading. The 10 Year U.S. Treasury broke through key technical indicators and closed above 2.84%. Some of the factors propelling Friday’s negative market include fears of inflation, mixed earning from big tech companies this past week, as well as rumors about global central bankers looking to reduce quantitative easing, and an unease with the rapidity of the market’s rise over the last few months.
In economic news, the January jobs report was solid with 200,000 jobs created. Unemployment remained at 4.100%. The big news (of which we have been warning our readers) is that there was an uptick in wage inflation. Bonds responded as expected and traded higher in response to the threat of increased inflation. Why is higher wage inflation scary, when one would think higher incomes are good for the economy? The answer is that for a long time, assets have been priced against ultra-low or negative interest rates. Rising inflation also affects bondholders as rising rates hurts bond portfolios. With the government debt yields moving higher, risky assets may become less appealing. All of this was at work this week.
In defense of interest rates, rates are still low from a historical perspective. However, we must keep in perspective that the reason interest rates are rising is that the economy is doing well. With the 10 Year Treasury hitting 2.85%, we remain cautious and biased toward locking-in interest rates unless you have the stomach to weather continued volatility.