Surging Real Yields Are A Critical Risk Factor
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Inflation-adjusted interest rates are rising, rapidly. It wasn’t all that long ago that pundits and markets were worrying about the fallout from negative real rates. In short order, the risk has reversed as the Federal Reserve persists with a hawkish policy run to tame inflation.
The reversal from negative to positive has been fierce and rapid for real rates. Consider how 5- and 10-year Treasury TIPS yields have soared in recent weeks. As recently as March, the 5-year TIPS was below -1.5%. As of yesterday (Sep. 26) it was +1.58%—a sharp ~300 basis points rebound in the course of around six months.
U.S. Treasury Inflation-Indexed Yields
The lightening surge in real yields has a wide range of implications for macro and markets—a change that is now front and center for monitoring risk factors. The crucial question: How far and how fast will real yields rise in the weeks and months ahead? The key inputs for guesstimating an answer: the path ahead for inflation, how the Fed reacts, the impact on the economy and recessions risk, to name a few of the obvious suspects.
Meantime, it’s hard to miss the implications for risk assets. The influence of real yields on the stock market (S&P 500) waxes and wanes through time, but at the moment the influence is potent once more. For the foreseeable future, it’s a reasonable forecast to say that higher real rates are a headwind for equity prices.
S&P 500 Vs. 5-Year Real Treasury Yield (Inverted)
A similar profile of negative blowback applies to other assets, including gold and other commodities. Meanwhile, some assets react positively: higher real rates are bullish for the US dollar, for instance.
The bottom line: as real yields rise further, the allure of locking in higher inflation-adjusted payouts strengthens.
Christian Mueller-Glissmann, a strategist at Goldman Sachs Group (NYSE:GS), advises:
“You can go to credit to get your nominal yield with relatively little risk, you can go to the TIPS market to get your real yield with relatively little risk, so your incentive to own equities is lower.”
