As markets move to price a U.S. interest rate liftoff, possibly even from March, 10-year Treasury yields have risen a quarter point since the year started. Even more interestingly, “real”, or inflation-adjusted U.S. yields are driving the moves with a 33 basis-point jump.
Real yields, while at the highest since last June, will remain deeply negative for a while. But their rise poses challenges for assets that benefited from the there-is-no-alternative reasoning. The past week saw stocks wobble, bitcoin tumble 8% and Nasdaq tech, the quintessential low-rate play, fell 4.5%. Graphic: Real yields, https://fingfx.thomsonreuters.com/gfx/mkt/egvbkjowdpq/Pasted%20image%201641767281191.png
Holders of longer-duration bonds are also likely nervous — such assets saw big outflows in the past four weeks, Goldman Sachs (NYSE:GS) notes.
Meanwhile, inflation isn’t letting up; euro area prices rose 5% year-on-year in December and Wednesday’s U.S. CPI reading is expected at 7%-plus. The ECB has stayed resolutely dovish however — board member Isabel Schnabel did say on the weekend the bank may need to act if energy price rises prove persistent. The euro started Monday 0.3% lower.
Stocks are trying to claw their way back up — U.S. and European equity futures are inching up even if Treasury yields, both real and nominal, are a touch higher.
So what happens to stocks if real yields continue rising? There have been episodes a-plenty when equities rose alongside real yields, most recently in the March 2020-February 2021 period when a 1.5 percentage real yield increase was accompanied by a 50% global equities return.
Noting this, Berenberg recently advised clients to stay put. The share of rate-sensitive tech however is now far higher than in the past which possibly changes the equation a bit.
Finally, let’s not forget the worrying geopolitics and fast-spreading Omicron, both capable of adding to inflation and dampening economic growth. Oil prices are extending last week’s 5% gain and U.S.-Russia talks look set to start later in the day with few expectations.
Key developments that should provide more direction to markets on Monday:
-German Finance Minister Christian Lindner and Paschal Donohoe, Eurogroup president hold press conference
-NATO head Jens Stoltenberg meets with Ukrainian Foreign Minister
– Kazakh president steps up purge of security agency
-No concessions, no breakthroughs: Russia, U.S. cast pall on Ukraine talks
-Evergrande onshore bondholders to decide on extension; fellow developer Shimao puts all projects on sale
-UK manufacturers positive about 2022