Spiking Yields Pierce Bonds & Growth Stocks

Interest rates are moving up faster than many had anticipated—a bittersweet signal for investors.

The U.S. 10-year Treasury bond yield topped 1.33% overnight on Wednesday, the highest level in about a year, while the 30-year Treasury bond yield reached 2.11%, also the highest in a year.

Yields have come a long way from their all-time lows set in 2020, when 10- and 30-year Treasury bond rates bottomed out at 0.50% and 1%, respectively (0.31% and 0.70% on an intraday basis).

The spike in rates can be attributed to growing optimism about this year’s rebound in the U.S. economy and expectations that inflation may run hotter than previously thought.

President Biden and his Democratic party are putting the finishing touches on their $1.9 trillion stimulus package, which, if it comes to pass, would add firepower to an already-impressive economic recovery.

A real-time gauge of economic growth from the Atlanta Fed indicates that GDP may expand by 4.5% in the first quarter. Any stimulus would only add to that robust number.

10-Year Treasury Bond Yield

Retail Sales Boom

Fresh data released on Wednesday that showed a 5.3% month-over-month gain in January retail sales—the third-biggest increase of the past 20 years—further adds credence to the idea of a muscular economic recovery, one that may lead to a broad-based rise in prices.

The difference between real interest rates on 10-year Treasury inflation-protected securities and the equivalent nominal bonds—a measure of expected inflation—clocked in at 2.26% on Wednesday, a seven-year high.

That’s what makes this spike in interest rates bittersweet. On the one hand, it’s a reflection of strong economic growth. On the other, it may be a sign of bubbling inflation pressures that may lead to an even bigger jump in rates, and potentially force the Federal Reserve’s hand in hiking its benchmark overnight fed funds rate. Those are bearish forces for stocks.

10-Year Breakeven (Inflation Expectations)

Bonds Crack

So far, markets have taken the rise in interest rates in stride. Most asset classes are not too far from either record or multiyear highs.

But bonds, whose prices are intrinsically linked to interest rates, are another matter. Long-term Treasuries have plummeted this year, while shorter-term Treasuries and corporate bonds have also struggled (bond prices and yields move inversely).

The iShares 20+ Year Treasury Bond ETF (TLT) is down 7.3% year to date, and the iShares 7-10 Year Treasury Bond ETF (IEF) is lower by 2.3%.

Corporate bonds have been more mixed. The iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD) is down 2.6% for the year, while the iShares iBoxx USD High Yield Corporate Bond ETF (HYG) is still up by 0.6% thanks to a tightening of credit spreads.

Junk bonds’ resiliency is a reflection of this year’s strong demand for riskier assets; high yield spreads are at their lowest levels since 2014.

YTD Returns

Off The Highs

Yet in a sign that some of the shine is coming off assets on the riskier end of the investment spectrum, growth stocks are taking a beating today. The high-flying ARK Innovation ETF (ARKK) is down 4.8%; the SPDR S&P Biotech ETF (XBI) is lower by 2.2%; and the Invesco QQQ Trust (QQQ) is slipping by 1.5%.

Granted, these are relatively modest moves compared with the enormous gains these ETFs have seen recently. Even after today’s losses, ARKK is up a whopping 19.4% on the year.

But these are the first indications that investors may be warily eyeing the rise in interest rates. After all, rates play a crucial role in the valuation of financial assets, and all else equal, higher rates equal lower valuations (and vice versa).

Of course, all else is rarely equal. Key factors like the economy, corporate profits and investor sentiment are constantly shifting. If, say, economic growth is truly robust, investors may look past the recent uptick in yields, especially if inflation pressures remain contained.

Conversely, if inflation gets out of hand, forcing interest rates much higher, that could spell trouble for long-duration assets—everything from long bonds to growth stocks to gold (which just hit a three-month low) could see their valuations compress.

In that case, the whole “asset prices are high because interest rates are low” narrative may be harder to defend.

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2