One of the year’s biggest spikes in Treasury yields has investors mapping out the impact of rising rates on markets ranging from stocks to corporate bonds.
Renewed optimism about U.S. stimulus talks pushed the benchmark 10-year yield to a high of 0.96% on Wednesday, a move which if continued could spark a domino effect across risk assets trading at all-time highs thanks to low interest rates. At issue is whether the jump in yields is accompanied by an economic recovery and moderate levels of inflation that would allow the Federal Reserve to keep rates low.
So far it seems investors are positioning for that scenario, with the Treasury curve — often a gauge of growth expectations — steepening and U.S. stocks holding near record highs. Ten-year breakevens — a market-based gauge of inflation expectations — though highest since May 2019 remain well below last year’s 2.2% peak.
A 10-year yield of 1% to 2% “is certainly possible, and it would have wide implications across everything from emerging Asian currencies to commodities,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore. “It’s likely a matter of when — not if — yields will climb.”
Ten-year Treasury yields rose about 2 basis points to 0.94% Wednesday as of 2 p.m. in New York.
Benchmark yields have tripled from their March lows on bets of a global economic recovery and a “return to normal” from the pandemic with the help of vaccines. A Bank of America survey last month found a record 73% of investors expected a steeper yield curve.
Here’s a look at what higher Treasury yields could mean for various asset classes:
Skyrocketing Stocks
One of the clearest winners from a modest rise in Treasury yields could be equities, particularly those most exposed to a reflating economy. The MSCI AC World Index is at a record, and rotation to cyclical shares such as industrial and materials names accelerated last month.
“To the extent yields rise, it’s likely to be on higher inflation expectations,” said Andrew Sheets, cross-asset strategist at Morgan Stanley. “Periods where yields were rising and the yield curve is steepening — those are some of the best periods for the stock market.”
But key to the bullish outlook for stocks is inflation remaining under control and economic growth returning. A return to the dreaded stagflation of the 1970s, for example, would quickly derail any rally in risk assets.
“You cannot rule out inflation returning — it could creep up on us through 2021, 2022,” said Stephen Miller, an adviser at GSFM, a unit of Canada’s CI Financial Group. “Yields will climb further and make it harder for central banks to control their yield curves, which will certainly create headwinds for equities and make them vulnerable to a reasonably significant correction.”
No Fear for EM
While higher Treasury yields have traditionally triggered a selloff in emerging market bonds and currencies, 2021 may prove different, according to strategists. Because the recent climb is linked to improved economic prospects, it’s also positive for developing nations, said Khoon Goh, head of Asia research at Australia and New Zealand Banking Group Ltd. in Singapore.
“With the Fed expected to keep policy very accommodative for some time, there is nothing for EM to fear at this stage,” Goh said.