You’ll never find a rainbow if you’re looking down.
Charlie Chaplin
Last month marked the one-year anniversary of the start of the new equity bull market. It also marked what will probably be a sustained rise of global bond yields. US 10-year treasury yields have risen from a trough of roughly 50 basis points at the beginning of March 2020 to a peak of approximately 175 basis points at the end of March 2021, with a substantial part of this increase taking place since the end of January 2021. Interest rate moves are driven by fundamentals and are often expected but the speed of the upward or downward moves can take investors by surprise. This time was no exception, with varying impact on risk asset classes varied somewhat.
The data shows clearly that the recent rise in interest rates has had a greater impact on higher-quality longer-duration securities, with US investment grade bonds and the FANGs (Facebook, Amazon, Netflix and Google/Alphabet) all losing ground with the rapid rises in bond yields. Given investors’ exposure to these segments of the market and the strong performance of the FANGs, it has not been surprising to see a rotation to investments that have shorter duration and greater exposure to cyclicality.
Looking forward to the rest of 2021 and into 2022, we are left with a number of fundamental questions:
Are rising yields on the back of a faster than expected global economic recovery a signal of the revival of sustained inflation? Or are they just a return to normal following the massive cuts in interest rates by central banks last year and the further post-pandemic monetary and fiscal intervention? Are risk assets now discounting the full recovery of the global economy and are equities in particular expensive and vulnerable to disappointments? How fixed income assets class be affected, in particular emerging market corporate bonds?
The drivers of higher bond yields are a combination of factors: strengthening prospects of much faster global economic growth facilitated in particular by the fast roll-out of the Covid vaccines in the USA and the UK, supported by accommodative central banks and substantial fiscal stimulus packages in many developed economies and accompanied by higher commodity and assets prices.