(Bloomberg) — A big pandemic-era distortion in the world of finance is well and truly over — and the new normal is helping fuel the worst cross-asset selloff in decades.
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After being trapped in negative territory during the lockdown days, inflation-adjusted Treasury yields are again breaking out, with five- and 10-year measures back near multiyear highs.
In another sign that the free-money era is no more, short-dated real rates suddenly jumped this week to the highest since March 2020 after finally turning positive in early August.
All this is bad for news for money managers across the board, with rate-sensitive allocations harder to justify from tech stocks to long-maturity corporate bonds. Rising real yields — seen as the true cost of money for borrowers — are rippling through the economy as mortgage rates soar while Corporate America adjusts to the higher cost of doing business.
It could get a whole lot worse. The thinking among Wall Street traders is that a hawkish-at-all-costs Federal Reserve is increasingly determined to engineer tighter financial conditions — via lower stock prices and higher bond yields still — in order to combat raging inflation.
That suggests investors in just about every asset class risk fresh market chaos, as Goldman Sachs Group Inc. projects 10-year real yields are moving closer to levels that would materially restrict economic activity.
“The next few months for equities will be bumpy and there is a risk of further drawdowns if this dynamic of rising real yields with decelerating growth continues,” said Christian Mueller-Glissmann, managing director of portfolio strategy and asset allocation at Goldman Sachs.
The latest yield surge with echoes of the June tumult began when Powell surprised investors at the Jackson Hole symposium with a somber message that borrowing costs will need to go higher and stay in potentially growth-restricting territory to get inflation down. Since then, 10- and five-year real rates in the US have advanced some 30 and 38 basis points while technology-heavy Nasdaq 100 Index has plunged 8%.
“It is likely that any push to new multiyear highs in real yields would likely correspond with a new leg down in stocks,” said Charlie McElligott, a cross-asset strategist at Nomura Holdings Inc.
Rising inflation-adjusted yields are putting pressure on the likes of tech shares because the latter’s long-term earnings prospects now have to be discounted at higher rates. At the same time assets bereft of income streams like gold and cryptocurrencies look less appealing given the greater opportunity costs to hold them compared to a Treasury bond that pays out a real return.
“There’s clear competition from higher real bond yields for any type of store value, especially more speculative, long duration ones,” said Mueller-Glissmann.
All this is a world away from the post-financial crisis era when central bankers sought to reflate the economy via historically low interest rates that sent money managers into riskier and riskier assets in order to eke out gains.
These days, the thinking goes that monetary officials are effectively seeking to anchor real rates higher to help moderate the excesses of the inflation-addled business cycle.
In an interview with Bloomberg’s Odd Lots podcast after Jackson Hole, Minneapolis Fed President Neel Kashkari noted that real rates are a driver of economic growth. He also didn’t rule out a scenario whereby inflation fails to reach the central bank’s target anytime soon, requiring higher borrowing costs.
Yet policy makers must tread carefully. The yield on 10-year inflation-protected securities is now less than 30 basis points away from the 1% tipping point that would start seriously hurting economic growth, according to Goldman Sachs analysis. And while the latest jobs report may give ammo to those who reckon the Fed can secure a soft landing, skeptics clearly outnumber optimists right now.
“A lot of the economic data is looking really uncertain so that usual offset to higher real rates — the economic optimism — just isn’t there,” said Morgan Stanley’s chief cross-asset strategist, Andrew Sheets, in an interview with Bloomberg TV. “That puts the market still in a tough position.”
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