Inward moves in the US Treasury market are eroding support for Wall Street’s pandemic-era equity gains, the latest blow to the speculative bets that have thrived in the era of rock-bottom interest rates and stimulus.
The 10-year Treasury yield is losing less and less money to investors when adjusted for inflation. One benchmark, the yield on the Treasury’s 10-year inflation-linked security, or TIPS, closed at 0% on April 19, according to Tradeweb. This is the first time it hasn’t been negative since March 2020, when global central banks cut interest rates to support economies in shock from the coronavirus pandemic.
Traders follow TIPS returns closely as they provide a measure of financial conditions and show whether the cost of borrowing for businesses and consumers is rising or falling when factoring in the impact of inflation expectations.
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TIPS holders are compensated when the consumer price index rises and end up receiving the same return as ordinary government bond holders if annual inflation equals the difference between the two returns.
While the rise in TIPS yields signals improved bond yields and a return to more normal growth and inflation as the Federal Reserve begins raising interest rates, it has hurt many pandemic-era high-flyers.
Yields on TIPS, often referred to as real yields, fell sharply into negative territory early in the pandemic, meaning investors were guaranteed to lose money on an inflation-adjusted basis if they held the bonds to maturity. This helped raise stock prices by pushing investors into riskier assets in search of better returns.
Now analysts believe that period will end when central banks withdraw efforts to stimulate economic growth by keeping interest rates extremely low and buying bonds. Many now expect the Fed to fight inflation with a series of rapid rate hikes, including a half a percentage point move next month.
The rise in real yields makes relatively safe assets like government bonds more attractive and hurts the value of start-ups and companies that are expected to make profits over the next few years. According to Dow Jones Market Data, the S&P 500 is on track for its worst April performance since 1970, when it fell 9.1%.
“We have seen real interest rates explode higher and almost touched positive territory in the 10-year range, making equities extremely vulnerable,” said Brian Bost, co-head of equity derivatives at Barclays. “‘There is no alternative’ is no longer a justification for hiding in stocks.”
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Bonds have fallen this year, and faster than investors expected. The benchmark 10-year Treasury yield is approaching 3% for the first time since 2018. Interest rate derivatives show that investors expect the Fed to raise interest rates to just over 3% from the current 0.25%-0.5%. next year.
“We went from not raising until 2023 to the Fed, which hiked up to 300 basis points until 2022. It was truly a cycle on steroids,” said Michael de Pass, global head of US Treasury trading at Citadel Securities.
This rapid shift in expectations has hurt shares in low-earning tech companies and speculative bets, including Cathie Wood’s flagship exchange-traded fund, ARK Innovation. The ETF targets companies it believes offer the greatest potential for innovation, such as Zoom Video Communications Inc. and Coinbase Global Inc. It gained popularity in 2020 as the Fed cut interest rates and investors sought high yields in riskier places. The fund, known by its ticker ARKK, is down 20% since early April, bringing its year-to-date decline to 44% on Monday.
An inversion in the US Treasury yield curve has been a warning sign of a recession for decades, and it looks set to flare up again soon. The WSJ’s Dion Rabouin explains why an inverted yield curve can so reliably predict a recession and why market watchers are now talking about it. Figure: Ryan Trefes
Rising interest rates raise the cost of borrowing for companies, giving investors an alternative way to earn decent returns, which can hurt stocks in general. However, the effect tends to be larger for so-called growth stocks, as investors see less value in uncertain future earnings when Treasuries can provide them with more guaranteed returns.
“For the first time in a while, fixed income probably looks attractive compared to riskier assets like the equity market,” said Lisa Hornby, Schroders’ head of US Multi Sector Fixed Income.
Ms Hornby said rates could still move higher depending on upcoming inflation data. “I think we’ve priced in 80 percent of the move. Does that mean we have prime yields? Probably not, but we’ve done a lot of work.”
Wall Street strategists note that real yields remain low by conventional measures and have room to rise as the Fed hikes rates and inflation eases. Many remain hopeful that a steady rise can avoid significant disruption to businesses or stock prices.
“They are still extremely low from a historical perspective, suggesting that the Fed may need to do more to tighten financial conditions before higher real interest rates begin to materially impact operations,” said Gennadiy Goldberg, senior US -Interest rate strategist at TD securities.
– Sam Goldfarb contributed to this article.
Write to Julia-Ambra Verlaine at [email protected]
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