'Real' Bond Yields Help Explain Market Moves

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No single factor can completely explain this summer’s surprising market moves. But one can help: so-called real yields.

Real yields are what you get on U.S. government bonds after compensating for inflation, and are typically associated with the yields on Treasury inflation protected securities, or TIPS. Right now those aren’t just low, they are negative.

At the current rate, if you buy ordinary 10-year Treasury notes, you can expect to lose, on an annualized basis, roughly a dollar after inflation for every $100 you own. It also means you might not want to own Treasurys at all. Stocks, gold, corporate bonds—any alternative that offers the potential for a positive return might seem more attractive than a likely loss.

Real yields are likely to feature heavily in the calculations of investors in coming months, as they attempt to gauge what is ahead after stocks’ long poststimulus run. To many, negative real yields are a key factor encouraging investors to keep taking risks, even after a recent tech-led selloff exposed concerns about stretched stock-market valuations.

Many see negative real yields as the intentional result of decisions by the Fed.



Photo:

Kevin Lamarque/Reuters

Here is the story of how real yields fell so far, and why they matter:

Many see negative real yields as the intentional result of decisions by the Federal Reserve. It cut interest rates to zero when the coronavirus pandemic hit. But the central bank has also been buying Treasurys and has signaled that it wants inflation to rise modestly above its 2% target.

The Fed’s stance has helped cap Treasury yields, since long-term yields tend to rise and fall in line with what investors think is going to happen to short-term interest rates. But it has also pushed down real yields by giving investors more confidence that the central bank will allow inflation to run hotter than usual once the pandemic has subsided.

For the Fed, low real yields aren’t an end in themselves. Their power is what they can do for other assets and the economy.

Right now, the extra yield, or spread, investors demand to hold investment-grade corporate bonds over Treasurys is below its 10-year average, despite the pandemic.

That has enabled companies to issue an unprecedented amount of bonds over a short period, making it easier for them to keep paying workers and making investments.

Stocks, too, are boosted by negative real yields.

LowER REAL Yields

15%

Weekly changes in the

S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

2008–19

10

Rising STOCK Prices

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Weekly changes in the S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

15%

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

10

Rising STOCK Prices

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

15%

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

10

Rising STOCK Prices

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

15%

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

10

Rising STOCK Prices

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

LowER REAL Yields

15%

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

Rising STOCK Prices

10

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the S&P 500 (%) and yields on 10-year inflation-protected Treasurys (percentage points)

LowER REAL Yields

15%

Week ended March 27:

Stocks rise 10.3%

Yields fall 0.5 pt.

Rising STOCK Prices

10

5

0

Falling STOCK prices

–5

–10

Week ended March 20:

Stocks fall 15%

Yields rise 0.5 pt.

–15

–20

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

One reason is that, in formulas used to estimate what stock prices should be, lower yields help pull down the so-called discount rate. That makes future corporate earnings more valuable, though greater uncertainty about the future can offset the positive impact.

All else equal, the decline in the nominal 10-year Treasury yield from 1.9% at the start of the year to 0.7% at the end of June could be seen as providing a 25% boost to the S&P 500, according to a report by Michael Sneyd and Kaushik Banerjee of BNP Paribas. The effect of falling real yields on stock prices should be similar, the authors said in an interview.

One of the most obvious consequences of the drop in real yields has been the weakening dollar. More often than not, when real yields have declined recently, the dollar has dropped with them.

Weekly changes in the ICE Dollar Index (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

HIGHER Real Yields

10%

8

Week ended March 20:

Dollar gains 4.1%

Yields rise 0.5 pt.

6

Strengthening dollar

4

2

Weakening Dollar

0

–2

–4

Week ended March 27:

Dollar loses 4.3%

Yields fall 0.5 pt.

–6

–8

–10

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

LowER REAL Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the ICE Dollar Index (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

HIGHER Real Yields

10%

8

Week ended March 20:

Dollar gains 4.1%

Yields rise 0.5 pt.

6

Strengthening dollar

4

2

Weakening Dollar

0

–2

–4

Week ended March 27:

Dollar loses 4.3%

Yields fall 0.5 pt.

–6

–8

–10

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

LowER REAL Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the ICE Dollar Index (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

HIGHER Real Yields

10%

8

Week ended March 20:

Dollar gains 4.1%

Yields rise 0.5 pt.

StrEngthening dollar

6

4

2

0

Weakening DOLLAR

–2

–4

Week ended March 27:

Dollar loses 4.3%

Yields fall 0.5 pt.

–6

–8

–10

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

LowER REAL Yields

Sources: FactSet (S&P 500); Federal Reserve Bank of St. Louis (TIPS yields)

Weekly changes in the ICE Dollar Index (%) and yields on 10-year inflation-protected Treasurys (percentage points)

HIGHER Real Yields

10%

Week ended March 20:

Dollar gains 4.1%

Yields rise 0.5 pt.

8

Strengthening dollar

6

4

2

Weakening Dollar

0

–2

–4

Week ended March 27:

Dollar loses 4.3%

Yields fall 0.5 pt.

–6

–8

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

LowER REAL Yields

Sources: FactSet (ICE Dollar Index); Federal Reserve Bank of St. Louis (TIPS yields)

With currencies, it isn’t just U.S. yields that matter but how they compare with the government bond yields of other countries, as investors tend to favor currencies that offer a better risk-free return.

Thus, the decline in U.S. real yields relative to German real yields has helped strengthen the euro against the dollar.

Like bonds, gold is an asset that investors turn to for safety. So it benefits when government bonds offer lower returns.

It also tends to climb when inflation accelerates, because it then takes more dollars to purchase the same amount of the precious metal. According to BNP, 72% of gold’s price changes have historically been explained by moves in real yields while another 21% has been attributable to shifting global inflation expectations.

Weekly changes in gold prices (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

10%

Week ended March 27:

Gold rises 6.5%

Yields fall 0.5 pt.

8

6

Rising Gold Prices

4

2

0

Falling Gold prices

–2

–4

–6

Week ended March 20:

Gold falls 9.2%

Yields rise 0.5 pt.

–8

–10

–12

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Note: London Bullion Market Association (LBMA) Gold Price, 10:30 a.m. London time fixing

Source: Federal Reserve Bank of St. Louis

Weekly changes in gold prices (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

10%

Week ended March 27:

Gold rises 6.5%

Yields fall 0.5 pt.

8

6

Rising Gold Prices

4

2

0

Falling Gold prices

–2

–4

–6

Week ended March 20:

Gold falls 9.2%

Yields rise 0.5 pt.

–8

–10

–12

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Note: London Bullion Market Association (LBMA) Gold Price, 10:30 a.m. London time fixing

Source: Federal Reserve Bank of St. Louis

Weekly changes in gold prices (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

10%

Week ended March 27:

Gold rises 6.5%

Yields fall 0.5 pt.

8

6

Rising Gold Prices

4

2

0

Falling Gold prices

–2

–4

–6

Week ended March 20:

Gold falls 9.2%

Yields rise 0.5 pt.

–8

–10

–12

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Note: London Bullion Market Association (LBMA) Gold Price, 10:30 a.m. London time fixing

Source: Federal Reserve Bank of St. Louis

Weekly changes in gold prices (%) and yields on 10-year inflation-protected Treasurys (percentage points)

2020

2008–19

LowER REAL Yields

10%

Week ended March 27:

Gold rises 6.5%

Yields fall 0.5 pt.

8

Rising Gold Prices

6

4

2

0

Falling Gold prices

–2

–4

–6

Week ended March 20:

Gold falls 9.2%

Yields rise 0.5 pt.

–8

–10

–12

–0.6

–0.4

–0.2

0

0.2

0.4

0.6

HIGHER Real Yields

Note: London Bullion Market Association (LBMA) Gold Price, 10:30 a.m. London time fixing

Source: Federal Reserve Bank of St. Louis

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Write to Sam Goldfarb at sam.goldfarb@wsj.com

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