/Stocks face the crosscurrents of higher interest rates and fiscal stimulus in the week ahead
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Stocks face the crosscurrents of higher interest rates and fiscal stimulus in the week ahead

Traders on the floor of the New York Stock Exchange

Source: The New York Stock Exchange

The Covid-19 aid package is on track for final congressional approval in the week ahead — and it could be a double-edged sword for markets.

The legislation should be greeted by optimism around the powerful lift it could give the stock market and the economy, but it could also be met with concern about what a historically large stimulus package could do to inflation and interest rates.

Stocks were mixed in the past week, with the Dow and S&P 500 higher, but the Nasdaq was dragged lower by interest rate-sensitive tech names. The benchmark 10-year Treasury yield has continued to press higher, revisiting its recent high of 1.61% on Friday, before trading at 1.54% in late trading. Yields move opposite price.

One wild card for stocks could be how interest rates behave around upcoming Treasury auctions.

There is a $38 billion 10-year auction on Wednesday and a $24 billion 30-year bond auction on Thursday.

Traders are watching these closely, after a historically weak 7-year Treasury note auction in February sent rates higher, even for the 10-year.

“We’re a little more cautious on them, just given what we saw in the 7-year and some Japanese selling pressure,” said Ben Jeffery, strategist on the U.S. rates strategy team at BMO Capital Markets.

He said Japanese institutions could be less interested in participating before the end of their fiscal year on March 31.

Stimulus coming

The Senate was expected to approve its version of the $1.9 trillion stimulus package and send it to the House for a vote during the week. Otherwise, the market is watching key inflation reports with the consumer price index expected Wednesday and the producer price index, scheduled for Friday.

“I think the markets will be watching closely the progress on the stimulus package,” said Michael Arone, chief investment strategist at State Street Global Advisors. “I think they’ll continue to watch the 10-year Treasury move and we’re going to get CPI data. That’s going to inform on those moves.”

He expects stimulus to remain a factor that could sway markets.

Inflation has been a worry for markets, since rising inflation could crush margins and corrode earnings power. For bond investors, it would erode value and make interest payments worth less.

“As long as the rise in Treasury yields matches the pick-up in inflation, I think the market will be able to handle that. I think the challenge is when yields get notably above inflation…I like to see them closely matched,” said Arone.

He said the market is concerned that the next stimulus package could overheat the economy and create inflation, particularly as it comes on the heels of the package approved in December.

“I think it lends to the conversation, ‘do you really need another $1.9 trillion?’ Arone said. “We’re going to pour more gas on the fire, and with this $1.9 trillion that’s what the market is concerned about.”

Consumer inflation is expected to remain somewhat muted for February, after the 1.4% rise year-over-year in core CPI in January. But the pace of inflation is likely to pick up notably in March and April, since the comparisons to last year, when the economy was shut down, will likely look extreme.

Choppy to continue

The S&P 500 was up 0.8% for the week, and the Dow was up 1.8%. The Nasdaq, meanwhile, was down 2%.

“I think ultimately the higher quality segments that got hit in tech and communications probably did need to see a valuation reweighting,” Sonders said. “Arguably, we had some micro bubbles in the market, and they may need to suffer more downside.”

She said investors may want to adjust the allocation of their holdings regularly instead of waiting to adjustments around the calendar

“If you get a two three week, four five day surge in a particular sector, pare some back,” Sonders said, nothing that’s the opposite of what most people do.

Week ahead calendar