Rising yield, so far so good

At the end of last year, there was a general consensus on market expectations for 2021 that improved market government bond yields would rise this year. In the second half of last year, the forecasts were based on the fact that the majority of financial assets had already offset the losses they suffered during the spring shock, with only advanced market bond yields at historically low levels, price cloudy economic prospects and lower inflation expectations. In line with the growth, government bond market yields finally started to catch up in the second half of 2020, and this year was also fast.

Despite public consensus, the market has been somewhat intimidated by rising earnings in recent weeks, and investors have begun to downplay the extent to which the stock market tolerates the upswing. The question system is based on the fact that pricing developed in recent years is based on “low in the long run” and therefore based on the fact that interest rates are very low in the long run.. It should be noted that despite rising in recent months, improved market interest rates are at historically low levels. 10 year U.S. Government bond yields are up 1.6 percent, the lowest level ever measured since 2020. Real interest rates have moved from a very low level, with a 10-year depreciation of 0.7%. It should also be noted that rising yields are basically a healthy process because they reflect better economic growth and the slightly higher inflation associated with it.

Over the past decade, government bond yields have begun to more than double, once in mid-2013 (boldly) and then in the second half of 2016. Both of these cases are recent examples of what happens in markets when government bond market yields increase.

In both cases, in addition to the government bond market shock, we found that stocks or corporate bonds did not suffer sustained losses until growth prospects began to deteriorate dramatically. Shortness of breath).

In the spring of 2013, the long-running U.S. Government bond yields rose 150 basis points in shock, in response to a central bank signal that it will begin to cut its monthly bond purchases in the second half of the year. Finally, purchases began to slow at the end of 2013, but by this time inflation had fallen steadily and deviated from the 2% target, thus lowering government bond yields after a sharp improvement.

Then in 2015-16 came an external shock, the Chinese economy began to slow sharply, commodity markets collapsed, and global growth prospects deteriorated significantly. U.S. The stock market plunged nearly 20 percent, leaving the central bank after its first rise in December 2015, eventually forcing it to shut down further interest rate hikes. The rate hike resumed in late 2016, with a strong economic recovery emerging in the second half of 2016. In line with strong growth, inflation rose again to over 2% in the second half of 2018, and unemployment fell to unprecedented levels since the 1960s, so the central bank saw continued interest rate hikes, raising the key rate to 2.5%. However, long-term interest rates did not accelerate with the rise in the central bank, while 10-year government bond yields rose again by more than 3 per cent, while the yield curve flattened rapidly, which is not a good sign for growth.

By the end of 2018, fears of a recession had intensified, including the outbreak of the Sino-US trade war. Forecast indicators began to deteriorate rapidly, and by 2019 inflation was back below 2 percent. U.S. Markets plunged in the fall of 2018 as stock indices lost 20 percent of their value. The central bank was initially wasted on further tightening, and then in the summer of 2019 began to cut interest rates, realizing that the problem was getting bigger.

I believe that the situation today is significantly different in many respects from the yield-increasing environment in 2013, and then after 2016,

However, this is not a high yield, but rather shows that external shocks, the recession in China in 2015 and the trade war that began in 2018 caused more turmoil in the stock markets.

In today’s situation The most important difference is the new operating structure of the central bankThe gist of this is that the central bank is targeting the average inflation rate, i.e., reductions of less than 2 per cent offset inflation above 2 per cent. In light of this, the central bank has been contacted several times recently that austerity may be on the agenda as inflation has been low in recent times, and only then if it is consistently higher than 2 per cent. After all, if this system had been in place earlier, the Fed would have begun to control the 2013 level relaxation later, and the 2016 interest rate hike cycle would not have been so aggressive.

The central bank has not only changed its interpretation of its inflation target, but also re-changed the basic philosophy of the economic environment. He believes very little in a Phillips-like relationship that describes the reverse relationship between the unemployment rate and inflation, which means that he is more courageous to tolerate a lower unemployment rate, showing that even low unemployment in recent years will not increase significantly.

The point of the changes is that the central bank will keep short-term interest rates very close to zero,

Current market expectations for 2022 increases appear to be high. Especially in light of the fact that the market is not currently expecting a modest rise in inflation. Indices that reflect expectations are currently priced at around 2.5% (these rates are related to headline inflation, against which the Fed Core-PCE is generally 0.2-0.3 percentage points lower). Expectations also show that the market expects higher inflation in the short term because they are more likely to be aggressive than the US. Expect only temporary significant price pressures from the budget. It is expected that the central bank will need more than this to start tightening.

So for a long time the U.S. I think government bond yields could rise even more steadily. Yields will not be high as the central bank begins to tighten, but because loose monetary conditions will lead to stronger prices and higher inflation in the market. Historical experience suggests that before the Fed tightening, the slope of the yield curve could go smoothly to 250 basis points, and now we are only at 140 basis points. Importantly, real interest rates remain low as long-term yields rise, although there is still room for current levels to shift from minus 0.7% to 0.5% in the post-2013 period. In this scenario, this kind of revenue rise is not basically a bad environment for the stock markets. Of course, the growth of the stock market depends not only on interest rates, but the essence of my writing is that the movements that have taken place so far and, possibly, should not be so bad that they should not rise too fast. The central bank released its latest quarterly forecast (SEP) yesterday, which continues to adhere to the December guidelines that interest rate hikes can only be expected after 2023, despite the economic situation improving on the expected interest rate path. The latest forecast is in line with the new structure of the central bank, and despite strong growth and rising inflation, the wait is on.

This article reflects the views of the author and does not necessarily reflect the views of the portfolio editorial board.

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