Bonds are selling off again, but for different reasons. Investors also need to behave differently.
In the U.S., yields on 10-year Treasurys have risen close to 1.4%. Optimism about vaccination campaigns, as well as positive economic and corporate data, have led derivatives markets to price in a chance that the Federal Reserve will—very slowly—start raising interest rates as early as 2023. Yields started moving up consistently in October, which started with them under 0.7%.
Despite all the talk in financial markets about higher growth begetting inflation, however, this month’s gyrations have little to do with expectations of rising consumer prices. Rather, it is inflation-adjusted yields—as measured by inflation-linked Treasurys, or TIPS—that are edging higher.
This is the opposite of what was happening before February. Earlier bond selloffs were driven by expectations that the Fed would allow inflation to be higher in the future. Even if the central bank acted to tighten monetary policy at some point, the belief that it would do so by less than inflation meant that financial conditions would actually get looser in “real” terms. This made stocks appear more attractive, particularly in high-growth sectors like technology.
The flip side is that equity markets are looking less appetizing now. The S&P 500 fell 0.8% Monday, and is down 1.5% since Feb. 12. Tellingly, technology stocks have fallen more than 4% over the same period. Shares of financial companies, which would likely benefit from higher interest rates, have gained about 4%.
Investors shouldn’t take this as a signal to sell everything.
On the one hand, technical factors unrelated to rate expectations could be exaggerating the market moves. Analysts at Bank of America, for example, posit that the bond selloff may have been amplified by banks and other mortgage holders trying to hedge the adverse effect of higher rates on their books. This might prove a temporary effect, and be undone by yield hunters flowing into Treasurys.
On the other hand, even a modest increase in real rates is creating winners. If sustained, the new trend could be the tailwind banking and other unloved sectors need to regain some luster after being beaten to a pulp in 2020.
In this case, enthusiasm for tech giants could abate somewhat, which tends to lower overall index returns. But this isn’t the same as TIPS reaching a “tipping point” that torpedoes the stock market. Yields remain deeply negative. And while interest rates are a factor in valuing equities, they are far from the only one.
What is key for further equity gains is that the Biden administration’s $1.9 trillion stimulus plan remains on track. The joke in the market is that sometimes “good news is bad news” if it means the Fed raises rates too fast. But this fear is likely misplaced: If real rates rose far enough to cause damage to stocks, officials’ past actions suggest that they would intervene to avoid derailing positive economic sentiment.
The recent equity rally has been driven by expectations of looser fiscal and monetary policy, and investors can rest assured that both are still in place. The bond selloff, though, is a reminder that sometimes portfolios still need tweaks around the edges.
Write to Jon Sindreu at [email protected]
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