Real yield spike blows losses in ‘everything rally’

Soaring real yields – the return investors can expect after accounting for inflation – roiled markets in early 2022 and were behind the slump in stocks, investors said. Tech stocks are flying high, investors say.

Yields on 10-year inflation-linked US Treasuries have risen 0.24 percentage points since the end of December to minus 0.86%, as investors bet on the end of the buying program. Federal Reserve bonds and bets on a rate hike from the US Central Bank this year.

The move comes at a time when investors are a little less worried about high inflation over the next decade, or at least more confident that the Fed can keep prices up.

Real yields have grown more than the yields on conventional U.S. Treasuries so far in 2022. That means the gap between the two — known as the spread and a measure of investors’ inflation expectations – fell slightly, from 2.60 percent. points to 2.58 percentage points.

In the turmoil of the bond market, with investors claiming that an increase in real yields is most concerned with riskier assets, the decline in everything from stocks to bitcoin in the wake of the crisis. the reversal of “everything goes up” during the pandemic as real yields fall. is associated with returns for properties of all stripes.

“Real yields are what really have an impact on markets and seeing them rise will really test risk assets,” said Seema Shah, chief strategist at Chief Global Investors.

For investors, the higher real yields on ultra-low-risk government debt make other assets relatively less attractive. That logic hurts especially for the prized corners of the stock market, which benefit most from very low interest rates.

The tech-focused Nasdaq Composite had its worst start to the year since 2016, falling more than 3% in the first trading days of the year.

For loss-making tech companies and businesses that only recently went public, the decline was worse, according to Goldman Sachs indexes. Shares of nonprofit technology companies are down 7% so far this year, while initial public offerings over the past year are down about 9%.

Higher real yields are also likely to lead to higher borrowing costs for companies, analysts say.

“Real yields tell you the true cost of funding, not behind inflation, so we’re going to learn a lot about the true health of a company’s balance sheet,” says Shah.

Research by Deutsche Bank analyst Jim Reid shows that corporate credit spreads – the extra return that investors demand from a company to lend to them compared to the US government – is increasingly correlated. with real yields in recent years, tend to expand as real yields rise.

Reid argues that highly indebted firms are sensitive to changes in real yields because they give a better indication than nominal yields about the sustainability of the firm’s debt burden.

Real yields in the U.S. fell to an all-time low in 2021, according to data, as investors worried about rising inflation poured a record $70 billion into a fund holding protected government bonds. Inflation protection, or Tips, throughout the year. from EPFR.

Column chart Cumulative flow into US inflation-protected bond funds ($ billion) shows investors last year braced for rising US inflation

Some analysts also attribute part of the real yield move in 2021 to limited supply: the Fed, through its quantitative easing program, bought $6.5 billion in tips a month, limited the availability of bonds to ordinary investors. The central bank owns about 22% of the outstanding Tips, up from 9% at the beginning of 2020.

According to Sam Lynton-Brown, head of developed markets strategy at BNP Paribas, with Fed purchases slowing and ending in the coming months, Tips prices are likely to fall – dragging down real yields . That could exacerbate the move to higher real yields.

“You’re effectively talking about the increased financial costs for the economy as a whole,” said Antoine Bouvet, a rate strategist at ING. “Unless people are much more bullish on growth, that’s a worry for riskier assets.”

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