Bonds sell out again, but for different reasons. Investors must also behave differently.
In the United States, 10-year Treasury yields rose almost 1.4%. Optimism about vaccination campaigns, along with positive economic and corporate data, has led derivatives markets to assess the possibility that the Federal Reserve will start – very slowly – to raise interest rates as early as 2023. Yields started to rise steadily in October, which started with them below 0.7%.
Despite all the talk in the financial markets about higher growth leading to inflation, this month’s fluctuations have little to do with expectations of higher consumer prices. Rather, it is inflation-adjusted yields – measured by inflation-indexed treasury bills, or TIPS – that are rising slightly.
This is the opposite of what happened before February. Previous bond sales were driven by expectations that the Fed would allow inflation to be higher going forward. Even if the central bank acted to tighten monetary policy at some point, the belief that it would do so through less inflation meant that financial conditions would ease in “real” terms. This has made stocks more attractive, particularly in high growth sectors like technology.
The flip side is that the stock markets look less appetizing now. The S&P 500 fell 0.8% on Monday and 1.5% since February 12. Tellingly, tech stocks fell more than 4% in the same time frame. Shares of financial companies, which would likely benefit from higher interest rates, gained around 4%.
Investors shouldn’t take this as a signal to sell everything.
On the one hand, technical factors unrelated to rate expectations could exaggerate market movements. Analysts at Bank of America, for example, believe the bond sale may have been boosted by banks and other mortgage holders trying to hedge the damaging effects of the higher rates on their books. This could prove to be a temporary effect and be negated by Yield Hunters flocking to treasures.
On the other hand, even a modest increase in real rates makes winners. If it holds up, the new trend could be the tailwind and other unloved sectors need to regain some luster after being beaten to dust in 2020.
In this case, enthusiasm for the tech giants could subside somewhat, which tends to push the overall returns of the index down. But it’s not the same as TIPS hitting a “tipping point” that torpedoing the stock market. Yields remain deeply negative. And if interest rates are a factor in the valuation of stocks, they are far from the only one.
What’s key for further equity gains is that the Biden administration’s $ 1.9 trillion stimulus package remains on track. The joke in the market is that sometimes “good news is bad news” if it means the Fed is raising rates too quickly. But that fear is probably misplaced: If real rates rose enough to cause damage to stocks, past actions by officials suggest they would step in to avoid derailing positive economic sentiment.
The recent rally in equities has been driven by expectations of looser fiscal and monetary policy, and investors can rest assured that both are still in place. The bond liquidation, however, is a reminder that sometimes portfolios still need edge adjustments.
Write to Jon Sindreu at firstname.lastname@example.org
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