This may not sound like a big move but for treasuries it is, both in absolute terms and even more so relative to the size of the yield at the beginning of the year. It also means that yields, while still low overall, are more or less back to where they were pre-Covid.
The reasons for the move up in yields are all very positive. Firstly, there is increasing confidence that the US will be able to put the pandemic behind it, with the White House saying it will have enough vaccines to inoculate every adult by the end of May.
Secondly, and linked to this, the US is anticipating a very strong economic recovery, supported by easy monetary policy from the US Fed and the recent passing of President Joe Biden’s massive $1.9tn fiscal stimulus package.
Higher growth tends to come with higher inflation and, indeed, inflation expectations have recently moved up – although markets are not pricing in worrying inflation levels, yet. This in turn has driven higher bond yields, which tend to correlate with nominal growth (real growth plus inflation).
What is good for the economy is not always good for markets though. As described previously, higher rates can depress the share prices of stocks and they are particularly cruel to companies that have most of their profits far out in the future.
The further in the future the profit is, the more it is devalued by higher rates and this knocked previously high-flying (and expensive) growth companies hard in February.
There are quite a lot of these in the US, which is part of the reason the US stock market performed so well when rates were falling, but it does mean that good economic performance could, somewhat surprisingly, be a headwind for US equities as well as for bonds in general.
That said, there are certainly assets that tend to do much better in a rising rate environment caused by better global growth (reflation): commodities that are more in demand as manufacturing and investment picks up; financials that make more money as they can lend out at higher rates; and ‘value’ companies as a whole, which tend to have less of their profits far in the future and more today and so are less sensitive to interest rates.
Even small cap equities tend to do better as the optimism inherent in a growing economy tends to benefit riskier smaller companies at the expense of larger (and usually safer) ones.
So, where to from here? Well, it may be that what we have seen recently continues. We may see a situation this year where positive news for us, in terms of lockdown restrictions easing and the economy recovering, translates into much more mixed news for markets in general.
