- Real US bond yields – defined as the current yield adjusted for inflation – have risen sharply over the past month.
- Real US 10-year rates are now above 1%. Janus Henderson analyst Ash Alankar said if they approach real GDP levels of 1.5-2%, the “impact will be meaningful”.
- Financial modeling indicates the US should avoid a recession.
- However, “our same models see risk resetting at higher levels across many asset classes”.
Global markets remained on edge overnight, as US stocks fell again and money moved into safe-haven assets such as the Japanese yen.
As Business Insider’s Jim Edwards highlighted last week, there are many factors behind the current round of risk-off sentiment.
But according to asset management firm Janus Henderson, “the epicenter of the market’s current re-balancing remains the bond market”. Specifically, the US bond market.
Last week, benchmark US 10-year yields jumped to a seven-year high of 3.26%. Since then, there’s been lots of talk in markets about real interest rates — calculated by taking the current yield and subtracting the rate of inflation.
Adjusted for inflation, real US 10-year rates have risen by around 30 basis points over the last month, to climb above 1%.
And Dr Ash Alankar from Janus Henderson said a key metric to watch is whether real interest rates begin to catch up with real economic growth.
“We wouldn’t consider that real rates are approaching dangerous levels until they exceeded real GDP expectations, in possibly the 1.5% to 2% range,” he said.
If that happens, then assets in the firing line would include growth stocks (e.g. the big tech companies), along with real estate and gold.
Now that the spread between nominal bond yields and inflation is increasing, it follows that a spike in inflation could push bond yields into dangerous territory.
But on that subject, Alankar had some “good news”.
Using Janus Henderson’s proprietary options pricing model, he said the numbers “do not suggest an imminent inflationary shock”.
“This gives the Fed the very valuable luxury of increasing rates in a disciplined and calm fashion,” he said.
“Such a measured pace provides the economy – and allocators of capital more specifically – sufficient time to adjust to higher real rates.”
And that could be important for the medium-term outlook, because markets can often adjust to higher bond yields as long as the pace of yield increases aren’t too sudden.
In fact, Alankar said rising bond yields are a positive in the sense that they reflect “the market gaining faith in the sustainability of US economic strength”.
“But it also means that the easy money conditions that borrowers became used to might be a thing of the past.”
So far, the US Fed has managed to tighten policy without causing a serious market shock.
Ultimately though, the recent rise in bond yields may represent a shift that will change the structure of global capital flows.
“Fortunately, we do not foresee any level of pain commensurate with a recession,” Alankar said.
“Unfortunately, however, our same models see risk resetting at higher levels across many asset classes.”