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Surging real yields blow hole in ‘everything rally’


A jump in real yields — the return bond investors can expect once inflation is taken into account — has jolted markets in early 2022 and is behind a pullback in high-flying technology stocks, investors say.

The yield on 10-year inflation-linked US government bonds has surged 0.24 percentage points since the end of December to minus 0.86 per cent, as investors position for the end of the Federal Reserve’s bond-buying programme and bet on interest rate rises from the US central bank this year.

The move has come at a time when investors have become slightly less anxious about high inflation over the coming decade, or at least more confident that the Fed can keep a lid on price rises.

Real yields have risen more than yields on ordinary US Treasuries so far in 2022. That means the gap between the two — which is known as break-evens and is a closely followed gauge of investors’ inflation expectations — has fallen slightly, from 2.60 percentage points to 2.58 percentage points.

In the bond market turmoil, investors say it is the rise in real yields that is most concerning for riskier assets, feeding declines in everything from stocks to bitcoin in a reversal of the “everything rally” during the pandemic when a collapse in real yields was linked to gains for assets of all stripes.

“Real yields are what is truly impactful for markets, and seeing them rise will really test risk assets,” said Seema Shah, chief strategist at Principal Global Investors.

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For investors, higher real yields on ultra low-risk government debt make other assets relatively less attractive. That logic is particularly painful for the highly valued corners of the equity market that have benefited most from very low interest rates.

The tech-focused Nasdaq Composite has suffered its worst start to the year since 2016, falling more than 3 per cent in the first trading days of the year.

For lossmaking tech companies and businesses that only recently went public, the declines have been worse, according to closely followed Goldman Sachs indices. Shares of non-profitable tech companies are down 7 per cent so far this year, while initial public offerings in the past year have fallen roughly 9 per cent.

Higher real yields are also likely to feed through to higher borrowing costs for companies, analysts say.

“Real yields tell you the true level of funding costs, without hiding behind inflation, so we’re going to learn a lot about the genuine health of corporate balance sheets,” Shah said.

Research by Deutsche Bank analyst Jim Reid shows corporate credit spreads — the extra yield investors demand a company pays to lend to it compared with the US government — have become increasingly correlated with real yields in recent years, tending to widen when real yields climb.

Highly-indebted companies are sensitive to changes in real yields, Reid argued because they offer a better indication than nominal yields of how sustainable a corporate debt load is.

Real yields in the US sank to all-time lows in 2021 as investors, rattled by the surge in inflation, poured a record $70bn into funds holding inflation-protected government bonds, or Tips, over the course of the year, according to data from EPFR.

Column chart of Cumulative flows into US inflation protected bond funds ($bn) showing Investors last year girded themselves for rising US inflation

Some analysts also attributed part of the move in real yields in 2021 to limited supply: the Fed through its quantitative easing programme has been buying $6.5bn of Tips a month, limiting the availability of the bonds for ordinary investors. The central bank owns roughly 22 per cent of Tips outstanding, up from 9 per cent at the beginning of 2020.

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With Fed purchases slowing and set to end in the months ahead, Tips prices are likely to slide — dragging up real yields — according to Sam Lynton-Brown, head of developed markets strategy at BNP Paribas. That could exacerbate the move higher in real yields.

“You’re effectively talking about financing costs going up for the entire economy,” said Antoine Bouvet, a rates strategist at ING. “Unless people are getting much more optimistic about growth, that’s a worry for risk assets.”



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