Thanks to a strong economy and the tax reform that lowered the corporate tax rate, Kathy Jones, chief fixed-income strategist at Charles Schwab, expects interest rates to "grind higher" this year.
During an interview with CNBC Tuesday, Jones said that, with the Federal Reserve pulling back from quantitative easing and central banks around the globe gearing up to do that as well, the market has to absorb a lot of supply that is bringing back volatility and higher interest rates. She noted that the economy is "running pretty hot" and that stimulus is being added at the same time, setting the stage for an increase in interest rates.
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At the end of last year, President Donald Trump signed the tax reform bill into law, reducing the rate corporations pay on their taxes and giving them the ability to bring back overseas cash at a reduced rate. That led to a surge in stock prices in January as investors bet that corporations will use the newfound wealth for capital investments and to reward shareholders. While the tax cut did result in some companies paying employees bonuses and raising salaries, it is not clear what the majority of the publicly traded corporation will do with the extra cash. Apple Inc. (AAPL), for one example, plans to spend all of its cash over an unspecified period of time, with reports pointing to it using the funds to buy back stock, raise dividends, and engage in mergers and acquisitions. Find out if you can make money in stocks.
"The stock market likes tax cuts a lot because it put more money on the bottom line," said Jones, noting that, while that is good news, she is skeptical that all of the money will be used for productive investments. The executive at The Charles Schwab Corporation (SCHW) noted that the economy is strong, with lots of growth potential given productivity and labor force growth remaining low, setting the stage for interest rate hikes.
As for the recent sell-off in the stock market, which has spooked investors who have gotten used to low volatility and securities that continued to go up, Jones said that volatility "is back and back in a big way and in a sudden way," and that is what investors need to get used to. She admitted that she was surprised by the volatility, not realizing how many leveraged bets there were against the volatility index (VIX). With stocks nearing the correction phase late last week, the increase in volatility resulted in a "massive" unwinding of short volatility positions and the forced selling of other stocks or assets to cover short portions. Schwab noted in a recent blog post that the short volatility trade has replaced the long bitcoin trade at the end of January.