Treasury yields started climbing again Wednesday, and tech stocks sank with the move. Investors may be worried about a repeat of last month’s Treasury-market trends.
The 10-year yield was up nine basis points, or hundredths of a percentage point, to 1.48% around midday Wednesday, according to Bloomberg data. And major stock benchmarks slipped as yields climbed: The S&P 500 was off 0.2% around noon New York time, while the tech-heavy Nasdaq Composite, seen as more sensitive to rising yields because of its constituents’ longer timelines for growth, was down 0.9%.
Stocks declined despite the fact that the move in Treasuries wasn’t as violent as last week’s messy trading, when yields briefly spiked after a “brutal” 7-year Treasury auction. But investors’ skittishness can be explained by looking under the hood of Wednesday’s climb in yields.
Most of the 10-year yield’s Wednesday advance has been the result of inflation-adjusted rates, also known as real rates, rather than inflation expectations. The yield on 10-year Treasury Inflation-Protected Securities, or TIPS, a measure of real yields because TIPS principal is adjusted with inflation, climbed roughly 6 basis points, according to Bloomberg data, while 10-year bond-market inflation expectations rose 3 basis points.
That means the market is reflecting expectations for incrementally tighter central-bank policy and greater future uncertainty around rate increases and inflation—market inflation forecasts aren’t rising much. In fact, derivatives markets are now pricing in three interest-rate increases from the Federal Reserve by the end of 2023, according to Goldman Sachs. In other words, the market has pulled forward forecasts for the Fed’s first rate increase to early 2023, from late 2023.
That matters because the consensus on Wall Street is that increases in yields are good for stocks if they are driven by an improving inflation outlook, while rising real yields lead investors to discount future growth at a higher rate. Rising real yields may also eventually prompt investors to see bonds as a more viable alternative to stocks, though with 10-year real yields still well below zero (at -0.75%) it isn’t clear when that would occur.
“For most of last year, breakeven inflation increased with real yields falling as markets faded deflation risk, and this has been supportive for most assets,” wrote strategists at Goldman Sachs in a Wednesday note. “Last month real yields increased with breakeven inflation flat or slightly down–such fast increases in real yields without better growth, e.g., due to a policy shock like during the US ‘taper tantrum’ in May 2013, usually weigh more on risky assets.”
So stocks may be wavering because the Treasury market’s Wednesday move seems to follow February’s script: Long-term yields are solidly higher, with the move driven by real yields.
Notably, however, the trend is different for shorter-duration securities, which bore the brunt of the market’s turbulence last week. The 5-year yield also climbed on Wednesday, but a greater proportion of its rise was driven by bond-market inflation forecasts: Investors are now betting on 2.5% inflation over the next five years, the highest since 2008, according to Bloomberg data.
So while investors are starting to bet on stronger growth and a tighter Fed, they doesn’t expect a tighter policy to undercut inflation any time soon. That means that the so-called reflation trade is still on, even with the market’s potentially unwarranted concerns about tighter policy. And strategists say that means yields can continue to rise, though likely not at the pace that they did in February. Yields rose 33 basis points last month, according to the Treasury Department.
“Bonds now offer a better buffer for growth shocks and central banks have room for pushing back against the recent increase rates. However, after some consolidation our rates strategists see a continued upward trajectory for yields into year-end, albeit with less upward pressure and sharp moves on real yields,” Goldman Sachs wrote.
The bank doesn’t expect that to have a lasting negative effect on stocks over the long run, either.
“This would be consistent with bond bear markets since the late 1990s, which have been relatively short and shallow due to anchored inflation and equities have usually done well, barring some temporary indigestion.”
Write to Alexandra Scaggs at [email protected]
