Rate Ransom
Price action in recent weeks provides solace for bulls. The S&P 500 notched a fresh record while U.S. financial conditions have loosened from June levels -- even as 10-year real rates have climbed. Resilient risk appetites, a still-low effective cost of capital and stellar earnings have powered American assets across the board.
And the beaten-up emerging market complex has defied the rise in the discount rate, with bargain-chasing real money investors shifting back into debt products and bearish voices in retreat. A Bloomberg currency index that tracks developing-market returns from carry trades is up nearly 2 percent this month on the heels of its worst month in over six years.
But higher real yields -- in tandem with the repatriation of greenbacks, the outperformance of American equities and the U.S. economy’s strong momentum -- give Citigroup Inc. cause to question the longevity of the rebound.
“We are still reluctant to call the peak in EM sell-off as the major underlying medium-term factors behind the USD magnet may be still in place,” strategists led by Luis Costa wrote in a note. The carry trade is only “temporarily” back, he said.
A cruel new world may await cross-asset money managers.
GMO LLC, a value investor with $71 billion in assets, projects negative returns across most asset classes adjusted for inflation for the next seven years, with cash in dollars alongside emerging-market assets offering the only source of gains.
While U.S. stock investors are taking the rate sell-off in their stride, markets are humming a decidedly late-cycle tune, according to Morgan Stanley strategists.
“Rising real rates here are not an automatic negative, but do reflect that an age-old pattern is unfolding: Better growth --> Fed tightening --> higher real rates --> slower growth --> equities, challenged by a higher discount rate and the growth drag.”
This article was provided by Bloomberg News.