Back in the 1990s, investors worried about a spike in bond yields if then US president Bill Clinton pushed through his planned stimulus package. James Carville, one of Clinton’s closest advisors, joked at the time that he wanted to be reincarnated as the bond market--rather than as a president, pope or baseball star --because “you can intimidate everybody.”
Some three decades later, investors are once again alarmed by rising bond yields. Since February, US 10-year Treasury yields have risen from 1.13% to about 1.70% immediately following the mid-March Federal Reserve meeting--reaching their highest level in the last year. Because higher bond yields can take the shine off riskier assets, such as equities, and deliver a blow to the discounted value of company cash flows, it’s understandable that investors are jittery.
No one is especially surprised that yields have moved upwards. But it happened a lot faster than expected, and not just in the US. Ten-year yields in several advanced countries have jumped even more than in the US. Not only have nominal yields picked up, but real yields have risen, too. While yield levels remain relatively low, the pace of acceleration has led investors to wonder whether this could disrupt equities and other risk assets.
Context matters, however. Today, yields are rising at a time of temporarily higher inflation and when economic growth looks set to accelerate, as vaccination efforts gather pace and lockdown restrictions start to be lifted. These dynamics--rising yields and faster growth--are inextricably linked.
Indeed, real yields and inflation expectations rise together when, like today, investors expect a strong, sustained economic recovery. A strong recovery allows investors in equities, corporate bonds and other cyclical assets to price in faster future growth.
Notably, any spike in inflation is likely to be temporary, so central banks aren’t planning any policy tightening. They may even step up their asset purchasing if financial conditions were to tighten unwarrantedly. Central banks clearly wish to keep government funding costs in check to continue to make fiscal stimulus affordable.
Investors should take a deep breath and consider rising yields in the appropriate context. What we see today is in fact typical of an early-cycle recovery and, overall, constructive for equities--even if it may lead to higher volatility.
As such, we see the current scenario as positive for markets, especially as we don’t expect central banks to hike rates for now. Importantly, the move higher has had a relatively contained impact on equities and credit spreads, while the US dollar hasn’t strengthened significantly. This means that financial conditions are still easy--not tight--despite the rise in yields.
Crucially, following the 2013 “taper tantrum”--when the Fed announced the future tapering of its quantitative easing policy and US Treasury yields rose sharply in response--the Fed is committed to being more transparent on its policy path.
We expect only a gradual tapering of Fed asset purchases from next year. And, with the expected inflation spike likely only temporary, actual rate hikes probably remain 2-3 years away. Worldwide, central banks are beginning to lean against any unwarranted tightening in financial conditions. The European Central Bank is boosting its bond-buying programme, and the Reserve Bank of Australia recently restarted its purchasing.
We remain pro-risk in our tactical asset allocation and believe the macroeconomic backdrop supports cyclical assets that outperform when growth accelerates. We think we are well positioned for a continuation of the recovery and reflation trade as activity picks up and economies reopen. We still expect real rates to stay in negative territory for the next several quarters, which is stimulative. With front-end rates anchored, the yield curve should steepen from here.
The recent combination of rising equities, commodities and bond yields could continue, with various drivers of this recovery and reflation trade leading at different stages. In parallel, the back and forth between periods of rate pressure and rallies in risk assets may remain a persistent part of the macroeconomic landscape over the coming months and, potentially, an occasional challenge for tactical risk-taking.