Just about the last thing the stock market needed as it tries to recover from the Dow Jones industrial average’s 4.6% plunge to start the week was a $300 billion deficit-boosting budget deal.
X The Dow Jones industrial average, S&P 500 index and Nasdaq composite sold off sharply as the 10-year Treasury yield jumped all the way back to 2.88%, within a whisker of last week’s four-year high. By the close on the stock market today, the Dow sank 4.15%, the S&P 500 3.75% and the Nasdaq 3.9%. The S&P 500 and Nasdaq undercut Tuesday’s intraday lows. Yet the renewed weakness in the stock market only dragged the 10-year Treasury yield moderately lower to 2.83%.
The S&P 500 and other major averages had already reversed lower Wednesday in part as the increased spending agreement took hold, lifting yields.
The trading action makes it look as if the stock market isn’t just climbing a wall of worry, it’s climbing a wall of debt, and that wall just got steeper. Already, Wall Street had been expecting $1 trillion in Treasury issuance in 2018, nearly double last year’s total. Now, the deal to boost spending on defense and domestic programs, while sending more money to hurricane-hit regions, could raise that total by $150 billion or more, with no letup in years to come.
IBD’S TAKE: After the Thursday, Feb. 1, market action — and before Friday’s and Monday’s market drubbings — IBD changed its market outlook to “uptrend under pressure” from “confirmed uptrend,” the equivalent of a green light turning yellow. Make sure to read The Big Picture column each day to stay on top of the market’s prevailing trend, so you’ll know when it makes sense to be aggressive and when you should move to the sidelines.
The heavier load of Treasury debt that needs to be issued to fund widening deficits comes as the Federal Reserve has begun gradually reversing government bond purchases it made to aid recovery from the financial crisis. The rise in Treasury yields needed to clear all of the new supply is generally seen as a negative for stocks, because higher interest rates can curb borrowing appetites and make stocks look like less of a bargain.
After Friday’s jobs report showed that average hourly wage growth accelerated to 2.9% in January from a year ago, markets suddenly started to price in a risk that dormant wage and price inflation may shift into higher gear, fueled by the Trump tax cuts.
Now, after the Senate budget deal that got a stamp of approval from House Speaker Paul Ryan, markets have reason to double down on those concerns. Whether or not Fed policymakers come right out and say it when they next meet in March, and New York Fed President William Dudley’s comments on Thursday suggest they probably will, the balance of economic risks has now clearly shifted to the upside, meaning the risk is that growth will come in too hot.
While details of the monthly employment report suggested the concern about accelerating wage gains was premature, it does appear that faster wage growth is coming. Walmart (WMT) announced in January that it was hiking base pay to $11 an hour, three years after it last announced a boost in starting pay to $9 an hour. On Thursday, CVS Health (CVS) said it also will adopt an $11 minimum wage in April. Both companies credited the tax cuts for their decision, though the competition for quality workers led Target (TGT) to boost its wage to $11 starting last October, when tax reform was still up in the air. At the time, Target made a commitment to raise its base wage to $15 an hour by the end of 2020. Starbucks (SBUX), JPMorgan Chase (JPM) and Wells Fargo (WFC) also are among the dozens of big employers who have hiked wages in the wake of tax cuts.
Even with tax cuts, the risk that wage growth will feed through to higher inflation has appeared modest enough for investors to mostly discount, as consumers have grown to expect internet price transparency and the ever-expanding reach of Amazon.com (AMZN) to keep inflation in check.
Those competitive dynamics help explain why Walmart, even as it hiked its minimum wage in January, also shut dozens of Sam’s Clubs employing about 10,000 workers, cut 3,500 store co-manager positions and thinned the ranks at its headquarters.
Yet now the risk of investors being caught flat-footed by a rise in inflation is growing as Washington prepares to unleash a second dose of fiscal firepower.
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