What Wall Street Is Revealing About US' Economic Outlook

Financial markets are optimistic about the combination of US government stimulus, low interest rates, vaccine performance and pent-up demand. 

Which means they believe there is money to be made for the foreseeable future. JL

Sam Goldfarb and Peter Santilli report in the Wall Street Journal:

Investors seem quite optimistic. Stocks are hitting records. Yields on U.S. government bonds and derivatives are suggesting the economy will be strong enough for the Federal Reserve to start raising short-term interest rates by 2023 and keep going for a couple of years. Major indexes have continued to climb this year even as Treasury yields have shot upward, another sign of investors’ confidence that the economy can withstand higher interest rates.(They)  are betting  a combination of government stimulus and coronavirus vaccines can drive a quick return to the economy that existed just before the pandemic.

What do investors expect from a post-pandemic economy?

They generally seem quite optimistic. Stocks are hitting records. Meanwhile, yields on U.S. government bonds and certain derivatives are suggesting the economy will be strong enough for the Federal Reserve to start raising short-term interest rates by 2023 and keep going for a couple of additional years.

In essence, investors are betting that a combination of government stimulus and coronavirus vaccines can drive a quick return to the economy that existed just before the pandemic. Back then, a decade of slow, steady growth had finally started to produce meaningful gains for even low-skilled workers.

Still, investors seem skeptical of an even-better outcome in which the economy’s capacity for growth is lifted by favorable demographic changes, technological innovation or government investment. Here is a closer look at investors’ bets on the economy.

Investors’ optimism about the future is apparent in stocks as well as bonds. Major indexes have continued to climb this year even as Treasury yields have shot upward, another sign of investors’ confidence that the economy can withstand higher interest rates.

That isn’t always the case. In late 2018, the yield on the 10-year U.S. Treasury note climbed as high as 3.2% with investors anticipating more interest-rate increases from the Fed. Stocks fell sharply and fully recovered only when Fed Chairman Jerome Powell signaled easier money policies.

This year, there have been some stock-market jitters as yields climbed. High-growth tech shares in particular are seen as more vulnerable to higher rates because their valuations are based more on future earnings. But the market has still managed to power forward, and even the tech-heavy Nasdaq Composite Index has bounced back recently—another sign that investors don’t expect a fundamentally different economy or rate environment than existed before the pandemic.

Investors have a decidedly mixed record of predicting the future, having repeatedly overestimated what short-term interest would be in recent years.

Federal-funds rate target with expected trajectory implied by futures

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Investors may have a natural bias toward preparing for higher rates since they stand to lose money on Treasurys if yields rise, said Roberto Perli, head of global policy research at Cornerstone Macro. That tendency could be even more pronounced when short-term rates are at zero and there is essentially only one way for them to move, given repeated statements from Fed officials that they don’t like the idea of negative rates.

Mr. Perli said some investors think: “I don’t think the Fed is really going to raise rates next year, but if it does my portfolio is going to lose a lot of money, so it’s sensible for me to hedge this risk.”