Three-minute macro: real rates, real concerns

The rise in real interest rates and the slowing growth of money supply are both on our radar this month. Longer-term, our team is also keeping an eye on how COVID-19 is exacerbating inequality issues in the U.S.

Real rates matter to equities

We are carefully watching U.S. real rates (nominal rates less inflation, which we measure using 10-year breakeven rates) as they have begun to move higher. Real rates have critical implications for a variety of asset classes and equities are no exception: this relationship has strengthened over the past 5 years, and even more so in the past 12 months with certain sectors being highly sensitive to these rate moves. We view real rates approaching positive territory as problematic to equities and would note that sharp moves are more important than small incremental moves.

Line chart showing the S&P 500 forward price earnings ratio and the U.S. real 10-year yield since 2014. They have become more correlated recently.

The inequality effects of COVID-19

The COVID-19 pandemic has further exacerbated income inequality in the United States, and we expect the Biden administration to prioritize redistributive policies in the coming months. The Democrats have an ambitious, progressive agenda that will likely include tax increases to ensure at least partial funding for the new spending programs, including the infrastructure bill that the Senate will look to pass during the summer. Incorporating tax increases should allow their policy changes to be permanent (as opposed to temporary COVID-19 relief) and would also serve to redistribute wealth. We expect markets to be sensitive to headline risks associated with tax hikes as the story evolves.

Line chart showing the growth of upper income limits for the lowest four quintiles and the top 5% of U.S population. The income of the top 5% has grown substantially faster than the lowest quintiles.

Less money, more problems (for emerging markets)

We view the topping out in global liquidity (using global money supply as a proxy) as a tactical headwind for Emerging Markets equities. Global liquidity has slowed markedly, with the deceleration in balance-sheet expansion from the Federal Reserve and the People’s Bank of China being major drivers of this dynamic. In particular, we see declining liquidity as an obstacle for the manufacturing sector, and given that Emerging Markets still depend heavily on that industry, we caution that the slowing growth of money supply may be a threat to both emerging market activity and earnings.

Line chart of the performance of the MSCI Emerging Markets Index and the growth of the global money  supply since 2017. Money supply growth has stalled recently, along with emerging markets’ performance.

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Erica Camilleri

Erica Camilleri, 

Investment Analyst, Multi-Asset Solutions Team

Manulife Investment Management

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Frances Donald

Frances Donald, 

Global Chief Economist and Global Head of Macroeconomic Strategy, Multi-Asset Solutions Team, Manulife Investment Management

Manulife Investment Management

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