(Bloomberg) — It’s fast and it’s furious and it’s toxic for other asset classes.
It’s the rise in 10-year US real yields — seen by some as the true benchmark for borrowing costs — which have soared over 150 basis points in the past 60 trading days, while the Federal Reserve turned ever-more hawkish. Investors calculate real yields by adjusting nominal ones for inflation.
That’s the biggest surge since the US government started selling inflation-protected securities in the late 1990s, surpassing routs during the global financial crisis and the Taper Tantrum of 2013.
Inflation-adjusted bond yields were negative for about two years, providing a key pillar of support for risk assets, which looked more appealing as a result. Their climb above zero has evaporated that positive backdrop, undermining equity valuations and threatening their relative attraction to bonds.
Positive U.S. Real Yields Will Rip Up Global Markets Playbook
Ten-year real rates have jumped to 0.88%, compared with a record low of minus 1.25% just seven months ago. The move accelerated after last week’s inflation report fueled expectations of more forceful rate hikes and helped push nominal 10-year Treasury yields to the highest since 2011.
The growing risk that the Fed will become more hawkish after concluding its policy meeting on Wednesday points to a further rise.
Rate Pain
All this is spurring big moves in risky corners of financial markets.
Over the past two years, negative real borrowing costs allowed everything from cryptocurrencies to profitless tech stocks to shoot to the moon, minting countless young millionaires who claimed old-school investors such as Warren Buffett were relics of the past.
Now these rate-sensitive trades are reeling. The received wisdom is that when inflation-adjusted yields rise, assets bereft of immediate income streams will naturally fall given the rising opportunity costs for investors who hold them.
At same time, rising yields hammer stock valuations by reducing the present value of corporates earnings ahead, especially those companies that can only generate cash flow years in the future. The price-to-estimated earnings of the Nasdaq Composite Index fell to about 21 this week, from 31 at the start of the year.
That’s not all. Higher US real rates are draining foreign capital away for leveraged emerging-market borrowers, sending currencies from the Turkish lira to Indian rupee to historic lows.
“Almost every EM currency weakens vs the dollar as US yields rise,” wrote Mitul Kotecha, emerging-market strategist at TD Securities in a note. “Much going forward will depend on the message the Fed delivers this week, but it’s hard to call a top in nominal US or real yields at present.”
(Updates throughout)
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