Real Yields’ Rise Is Canary in the Coal Mine for Risk Assets

For all the fear and angst about the risk of long-term Treasury yields lurching even higher, a true warning for global investors would be a surge in real rates.

While higher real yields signal the economy is gaining traction, a potential pickup in the pace of increases that occurred in recent days would bode poorly for the cost to borrow. In addition, a rise in yields might create potential rivalry for other asset classes that have benefited from negative real rates, including stocks, which are currently trading near all-time highs.

“This means the economy is on the mend; so it’s not unhealthy that real yields are rising,” said Mark Holman, chief executive officer at TwentyFour Asset Management. “But I caution that if real yields rise too quickly, then that’s a problem for all asset classes. It’s the speed of the change that could be a worry.”

That concern is already on investors’ radar even as U.S. real yields -- as measured by the rate on 10-year Treasury Inflation-Protected Securities, known as TIPS -- are nowhere near alarming levels. In fact, 5- and 10-year TIPS rates remain firmly below zero, at minus 1.87% and minus 0.95%, respectively.

Real Yields’ Rise Is Canary in the Coal Mine for Risk Assets

Treasury yields have climbed this year on speculation that President Joe Biden will authorize more fiscal relief measures to boost economic growth. January data on retail sales, industrial production and producer prices published Wednesday all came in above forecasters’ estimates.

For Kathy Jones, chief fixed-income strategist at Charles Schwab, the increase in real rates is indeed a reflection of the fact that the economy is improving. But she says that it could also signal competition for assets that had thrived when those yields were so low, such as dividend-paying stocks and real-estate investment trusts.

“The rise in real yields is important and shows that in many ways the true cost of capital is increasing,” Jones said. “The movement is a reflection of the fact that the economy is doing better, the recovery is going faster than expectations and that we have the stimulus and the vaccine roll out.”

Faster inflation expectations have been the key force for the surge in nominal Treasury yields to an almost one-year high of about 1.33% on Wednesday. Ten-year breakeven rates, garnered by the gap between yields on plain vanilla Treasuries and TIPS, hover at 2.22% -- up from as low as 0.47% in 2020.

One of the reasons stoking the jump in inflation expectations is the Federal Reserve’s insistence that it won’t put the brakes on its easy policy for now -- allowing for prices to run above its 2% target for some time. Minutes from the Fed’s last monetary policy meeting showed officials did not see the conditions for reducing their massive asset-purchase program being met for “some time.”

And Thursday’s auction of $9 billion worth of 30-year TIPS also stands to give a fresh test of just how much investors fear rising price pressures down the road as the economy reopens.

“It’s an onus for investors to be cognizant about real yields,” said Gary Pollack, head of fixed-income for private wealth management at Deutsche Bank. The increase in real yields is “an omen for the future that interest rates could rise further.”

©2021 Bloomberg L.P.

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