Expect 2022 to be “a year of policy tightening”, says Andrew Sheets of Morgan Stanley. This time last year, investors thought America’s Federal Reserve wouldn’t raise interest rates until April 2024. As recently as last August, market pricing still implied that “liftoff” wouldn’t come until April 2023. Yet with inflation soaring, the Fed has been forced to take a more hawkish stance. Traders are now expecting the first rise as soon as this March.
Bond yields spike
The dawning realisation that money is about to get tighter caused the biggest weekly sell-off (and resulting rise in yields) in the US ten-year Treasury bond since 2019. The yield on the ten-year Treasury topped 1.8% on Monday, a level not seen since before the pandemic began, and up from less than 1.25% in August. Meanwhile, the yield on the German ten-year Bund has come within spitting distance of zero. Germany’s benchmark bond has had a negative yield for almost three years, meaning investors have effectively been paying the government for the privilege of lending it money. That strange state of affairs may not last much longer.
Higher yields are likely to be bad news for popular growth stocks, including many fashionable firms in the tech sector. When interest rates are low investors are happy to take punts on unprofitable, fast-growing businesses that they hope will reap rewards in the future. Conversely, better bond yields may tempt some to take advantage of safer returns in the here and now instead.
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Tech stocks have been especially spooked by hints that the Fed is examining how to reduce its $9trn balance sheet (ie, putting quantitative easing into reverse), says Katie Martin in the Financial Times. On Monday, the tech-heavy Nasdaq index briefly entered correction territory, after falling 10% from its last peak in November.
A stronger economy
“Rising yields aren’t all bad news,” says Sam Goldfarb in The Wall Street Journal. Higher yields on long-term debt may signal that investors feel positive about the economy. Indeed, as tech sold off, shares “in economically sensitive sectors such as banking, industrials and energy generally rose”. US financial stocks have had their “best five-day start to a year since 2010”.
Nonetheless, the S&P 500 has fallen more than 2% since the start of the month, reflecting how big an impact the tech sector now has on its performance. US stocks have beaten the rest of the world for four years running, says Joe Wallace in The Wall Street Journal. Last year the MSCI USA index did 19 percentage points better than the rest of the world in dollar terms , the biggest margin of victory since 1997.
Yet with Apple’s value now comparable to that of the entire UK FTSE 100 index, some analysts question whether the outperformance can continue – especially if the US Federal Reserve raises interest rates faster than many other central banks this year. The challenge for US policymakers will be to tighten policy through “baby steps” without prompting the market to “throw its toys out of the pram”, says Mark Dowding of BlueBay Asset Management.
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