By David Randall

NEW YORK (Reuters) – The Federal Reserve’s signal that it will soon unwind its bond buying program is bolstering the case in financial markets for the so-called reflation trade, which lifted Treasury yields and boosted shares of banks, energy firms and other economically sensitive companies in the early months of 2021.

The reflation trade was unable to move during summer. The central bank indicated this week that they would probably begin to reduce its $120 million a month program for purchasing government bonds. It also said it could raise interest rates in 2022 earlier than most expected. [L1N2QN1LU]

Though monetary tightening is frequently seen as a drag on stocks, some investors view the Fed’s stance as a vote of confidence for the U.S. economy.

Ralph Bassett from Aberdeen Standard Investments, who heads North American equity, stated that a normal hawkish turn in monetary policy would hurt risk-on assets. However, the Fed’s announcement signals to investors that the U.S. economy is stable.

Although the Russell 1000 Value Index, which includes reflation-trade stocks, has seen a 0.9% increase since the beginning of the quarter it is still well below the 5.7% growth in the Russell 1000 Growth. Year-to-date, the value index has increased 17% while the growth index has grown 19%. This compares to 18.7% for the Russell 1000 Growth index.

Market watchers are also keeping an eye on Treasury Yields. These have been rising since the Fed meeting because some investors have moved out of safer-haven government bonds.

Recently, the benchmark U.S. 10-year yield was 1.45%. This is close to its highest point since July. Some stocks are less appealing due to higher Treasuries yields.

UBS Global Wealth Management’s analysts believe that the 10-year yield would rise to 1.8% before year end, although they don’t think this will cause a disruption in equities. The pace of any rise would be key: the bank’s research showed that a three-month change in nominal yields of between 50 and 100 basis points has been accompanied by a 5.7% return in the MSCI US index since 1997.

“Only a rise in real yields of more than 50 bps over three months would likely weigh on equity returns, particularly in emerging markets,” the bank said in a report.

The next week’s U.S. economic indicators will be closely monitored by investors. These include durable goods orders and ISM manufacturing, along with the status of the debt ceiling negotiations in Washington.

The Evergrande scandal will be closely watched by investors. This is after a heavily indebted Chinese firm missed the payment deadline for a dollar bond. Global investors are now wondering whether they’ll have to take large losses once the grace period expires. [L1N2QQ02J]

Margaret Patel, a senior portfolio manager of equity and fixed income funds at Wells Fargo (NYSE:), said Fed tapering should benefit high-yield bonds because it implies a stronger economy that will result in fewer corporate defaults.

Jim Paulsen of the Leuthold Group, chief investment strategist, stated that the trend in U.S. coronavirus count will have an impact on financial markets. The U.S. economy rebound was hampered by a COVID-19 revival earlier in the year.

His comments were directed at small caps and value stock.

Centers for Disease Control reported that the U.S. current case counts are now at 146,182, an increase of 6.1% over seven days ago. But, they saw a decrease of 1.8% in positive tests for the virus.

Capital Economics analysts said that investors’ confidence in the country could be affected by prolonged fighting over the U.S. debt limit.

Just days remain before the U.S. Senate votes on a bill to lift the $28.4 trillion debt limit and allow federal agencies to continue operating until Sept. 30, which is the end of fiscal year.

“Next week the focus will shift to fiscal policy,” Capital Economics said in a report. “A debt ceiling crisis in late-October could even delay the Fed’s taper plans,” the firm said.