Stock and Bond Markets Diverged

Stock and Bond Markets Diverged

| December 21, 2021

Last week, the Bank of England surprised markets with a rate hike, its first in three years, and the Bank of Mexico raised rates more than expected. Both cited persistent inflation as the reason for the increases, reported Carla Mozée of Markets Insider.

In the United States, the Federal Open Market Committee (FOMC), which is the group that decides how the U.S. central bank (the Federal Reserve or Fed) will manage monetary policy, met last week and decided to become less accommodating more quickly.

With inflation at high levels and employment at full pandemic capacity, the Fed will take steps “to prevent higher inflation from becoming entrenched,” announced Fed Chair Jerome Powell. FOMC median projections suggest the Fed funds rate will rise from its current range (zero to 0.25 percent) in 2021 to 0.90 percent in 2022, and 2.1 percent by 2024.

San Francisco Federal Reserve President Mary Daly told The Wall Street Journal, “If we see that the economy is delivering high inflation, even if we expect that inflation to not persist past the pandemic, and we see the labor market is extremely tight, even though we don't expect that to be true past the pandemic, then the policy action that would be appropriate is, after tapering, to raise the interest rate,” reported Ann Saphir and Howard Schneider of Reuters.

Major U.S. stock indices declined following the FOMC meeting, reported Ben Levisohn of Barron’s. The reason for the decline is unclear since research suggests that, historically, stock markets have moved higher following rate hikes. Anne Sraders of Fortune reported:

“Analysts at Deutsche Bank identified 13 separate hiking cycles since 1955, which lasted an average of under two years. And according to their research, which examined the average price performance of the S&P 500…‘there tends to be solid growth in the first year of the hiking cycle, with an average return of +7.7% after 365 days…’”

As stock markets declined, bond markets rallied. Yields on Treasuries of many maturities finished the week lower.7 That was surprising because the Fed raises the Fed funds rate to push interest rates higher. However, bond investors appeared to be more concerned about the spread of the Omicron variant of COVID-19, reported Yun Li and Vicky McKeever of CNBC.

“The world will not see a re-run of the spring of 2020, with jaw-dropping drops in [economic growth]... Even so Omicron—or, in the future, Pi, Rho or Sigma—threatens to lower growth and raise inflation. The world has just received a rude reminder that the virus’s path to becoming an endemic disease will not be smooth,” reported The Economist.

photo by:  Higher Interest Rates.   © Paulus Rusyanto |