Why equity investors are really starting to worry about rising bond yields

Equity investors are desperately trying to interpret what a rise in bond yields means for the stock market.

Since February 10, 10-year Treasury bill yields – which are not adjusted for inflation – have risen from 1.13% to 1.61%, up 48 basis points, the highest level in one year. (One basis point equals 0.01%)

Fear of inflation is leading investors to speculate that the Federal Reserve may need to change policy sooner than expected, either by cutting bond purchases or even raising rates at some point. It would be a disadvantage for the stocks. As of Thursday’s last count, the Dow Jones was down 500 points.

According to Peter Tchir of Academy Securities, the recent rise in 10-year bond yields represents a perception of inflation, but not necessarily the reality: “The rise in 10-year bond yields does not reflect a real rise in the inflation, it reflects that investors expect there will be a rise in inflation, ”he told me.

Tchir notes that Federal Reserve Chairman Jerome Powell rebuffed the idea of ​​excessive inflation, noting in his testimony that broad signs of inflation were not present in the real world and that if they did such increases would be “transient”.

Bond investors are worried about the potential for inflation. Powell says to stop worrying about it. Who is right?

It depends on who you ask and what you are watching.

Do we see inflation in the real world? We are doing it in commodities: oil is nearing the highest since 2018, for example, and copper has been at a high for almost 10 years.

But signs of consumer inflation, for example, have been dampened, with inflation at or below 2% for many years.

Bulls like Tchir insist that, in this case, the rise in bond yields is not a negative factor for stocks: “This time the rise in yields is coming from economic growth, stimulus measures and infrastructure. All of this is good for equities. That is why this increase does not scare me too much. “

He says that the rise in commodity prices can be easily absorbed, and believes that much of the rise is only a temporary condition reflecting the reopening, and that prices will return to “normal” levels with the time.

Hans Mikkelsen, credit strategist at Bank of America, is not so sure. He agrees with Tchir on economic growth, but thinks it will be much stronger than expected and that this will push inflation up: “Since the summer of 2020, economists have constantly underestimated growth. economical at a level never seen before. It appears a real risk the Fed will not be able to appear accommodating for much longer and this transition could result in wider credit spreads.

The key to the game, Tchir insists, is whether Powell can stick to his guns: “If the Fed remains committed to keeping short-term yields low, that will reassure people, we won’t get a ‘smack. tantrum ‘, where rates suddenly Powell told us he was comfortable with inflation and was not going to react to short-term movements. I think he’ll stick to his guns. “

There’s another problem: because stock prices are so high, there is no room for error. Slight variations in returns could push tech investors in particular to take profit, assuming it’s as good as it gets.

Michael Farr, veteran stock commentator for Farr, Miller & Washington, has previously told clients that even this relatively modest rate hike is a signal: “The days of crowding in among the market leaders. , whatever the valuation, may be coming to an end. Investors must now recognize that there are alternative opportunities, including hitherto underperforming stocks as well as increasingly attractive bonds. A strong economic rebound combined with rising interest rates and higher inflation, if it does happen, will change the investment environment significantly. “