- Yields starting to pressure markets
- Nasdaq and EM are most vulnerable
- Fed will likely try to ignore the spike
- 1.50% is the key point on the charts
- Swift rise could force Fed into YCC
- For stocks volatility ahead
Suddenly yield is a problem. US 10 year yields continued to rise today trading above the 137 basis points on the benchmark 10 year rate more than doubling from their COVID lows less than a year ago.
On an absolute basis yields remain low, but markets are never about absolute but rather relative valuations and the recent yield spike is starting to impact other asset classes as markets begin to realign.
Nasdaq and EM Feel the Pain
Stocks are clearly feeling the pain with high tech Nasdaq down the most losing more than 1% so far today. Although the Nasdaq index holds some of the most profitable companies in the US economy it is perhaps most vulnerable to a correction. That’s because in a near zero interest rate regime investors were willing to pay almost anything for an incremental dollar of profit which in turn has pushed the valuation of the index to historically record high levels. If yields continue to rise Nasdaq stocks will experience a compression of price earnings multiples which will more than offset any additional growth those stocks will record.
However, the greatest pain may be reserved for emerging market currencies such as the USDBRL or USDTRY. As, Robin Brooks former Chief strategist at Goldman Sachs notes –
Part of the reason for EM FX is so vulnerable is the unwind of the carry trade as US yields become more competitive, but the real damage of high US yields is in both the EM FX and credit markets. As the dollar rises versus the EM currencies their ability to import key commodities – all of which are globally priced in dollars – becomes far more problematic. Additionally many EM corporations are forced to issue debt in USD versus local currencies and as the value of dollar rises the cost of debt services increases as well. So a rise in US yields could be so detabiizing to EM economies that it could offset any post COVID bounce as the economies return to normal capacity.
Fed Will Try to Ignore the Move – Until 1.50%
All of this is not lost on the Fed, which no doubt is watching the rise in yields very carefully. The markets will keep a sharp eye on Chair Powell as he testifies in front of Congress tomorrow. He is unlikely to deviate from his normal policy guidance and will most probably insist that the inflationary impulse in the markets is temporary and in some ways welcome as it suggests that credit markets are beginning to price in a growth recovery. Still, US yields will become a much bigger headache for the Fed if they breach the key 150 basis point level.
As Helene Meisler showed, the 150bp level is both a key chart point and psychological level. A break through that point could trigger a momentum move that would quickly push rates to the 2% and force the Fed to consider yield curve control in order to keep the rate curve from steepening too fast. Given Mr. Powell’s cautious deliberate nature it’s unlikely that he would hint at such action in tomorrow’s testimony but if he does the recent spike in yields could hit a brick wall.
For equity investors however, the spike in yields, the likelihood of massive fiscal spend and the unfavorable seasonality all point to more volatility ahead.