In a week in which there is not one but two critical central bank announcement within hours of each other on September 21 – first the Fed, followed hours later by the Bank of Japan – there is just one asset traders should keep an eye on: the 10Y Treasury.
As Goldman shows, as a result of an unprecedented scramble for duration over the past year courtesy of global NIRP, the sensitivity to bond yields is at its all time highs across all assets, which means whatever the 10Y does, everything else will do, especially as a result of the ongoing rout in risk-parity and systematic funds which create a positive selling (or buying) feedback loop.
For bonds, the beta to US 10-year yields is the most negative since data begins in the mid-1990s: this is a technical effect, as in a negative-rates world most bonds increasingly resemble zero-coupon bonds.
What about stocks? As GS observes, while equity investors also fear higher rates, they are not necessarily negative for equities and risky assets more broadly: this will depend on the speed and driver of rate increases.
Indeed, as we showed previously, in a time when Risk Parity funds have become the marginal price setter across all asset classes, a rapid deleveraging will lead to substantial losses in both bonds and equities.
This is also confirmed at the macro level: historically, with anchored inflation and low bond yields, rises in yields have tended to reflect better growth, supporting equity performance as investors lower the required equity risk premium. However, for this virtuous relationship to hold, growth needs to pick up alongside yields and rate volatility should be low, something we have failed to observe so far in this entire business cycle. If bond yields increase too rapidly, such as during the ‘taper tantrum’ in May 2013, the ‘Bund tantrum’ in April 2015, and the most recent Taper Tantrum II…
… “equities tend to struggle” Goldman concludes.
Which is why in the coming days, traders will have to keep an eye on two key things: not only the yield on long-dated bond yields, which have seen a substantial jump in the past week courtesy of the “chaos unleashed by the BOJ”, but the speed with which such a repricing takes place.
Finally, as for asses which assets are most susceptible to a sharp move lower following a spike in real yields, Goldman points out that “very few assets are likely to benefit from higher US 10-year real yields currently: the duration is very low/negative compared with the past 10 years due to the search for yield. The Yen and European and Japanese equities are likely to benefit from the underlying policy divergence.” Here is the full breakdown: