Surging Bond Yields and Tech Rotation?
Government bond yields have been making headlines since the start of the US-Iran war and we are seeing a common thread among all G7 countries. This week saw US 10-year Treasury yields touch 5.2% for the first time in around 20 years while the Japanese 10-year breached the 3% mark. UK Gilt yields alse reached highs not seen since Covid.
While the velocity and magnitude of the rise in rates is notable, the reasons for the moves are more valuable for investors to understand.
Long-term inflation expectations have picked up since June. The market seems to be pricing in an inflation shock that is not currently priced into the markets, but is being priced into bonds.
Fiscal sustainability has come into question. The US deficit continues to climb with seemingly no party or political body terribly interested in reducing it. That combined with rising borrowing costs creates a need for change somewhere in the system. The change may just be the cost of capital in the form of rising interest rates.
Debt Supply is limited. There is only so much money available for governments, municipalities, and companies to borrow. Hyperscaling tech companies need a lot of capital. Several countries that are currently at war need a lot of capitol. And then there are small and medium sized businesses that regularly grow and require capitol. Not to mention the lowly consumer who still needs capitol to purchase cars, homes, and other borrowing needs.
Geopolitical risks are leading to investors demanding more return especially for longer term debt.
Governments all would prefer to have lower borrowing costs but the reality is that the market determines rates. Treasury Secretary Scott Bessent has tried to ease borring costs on long-term US debt with increasing Treasury buybacks, but the market is so much larger than the money available for the buybacks.
The Good
We have waited a long time for fixed income returns to return to these kinds of levels. The fixed income portion of your portfolios are finally set to have decent returns for the next few years. Yields on most intermediate-term bond funds are in the 5-6% range now.
While bond markets have been a bit volatile, flow of credit hasn’t slowed. Corporate bond yields are newar their highest levels pre-2008.
Corporate fudamentals remaine strong. Balance sheets and cash on hand are stable, profits have been steadily increasing.
Attactive yields plus strong fundamentals can deliver income and resilience.
In a world where government debt may be less of a diversifying tool, high-quality corporate bonds can help fill the void.
The Concerns
Fiscal trajectory
The hierarchy between “risk-free” government debt and corporate bonds has become a bit murkier than in recent history.
Other Asset Class Notes
Tech stocks have been doing the work for the last few years but there is broadening happening. It’s clear that AI investments and commodities have driven profit, but the AI story is maturing and so are the risks. The key questions have moved to will AI work, can it continue to be financed and how, how does the supply chain limitations such as chips affect the trajectory, etc. The markets have seen a bit of a rotation to emerging and developed markets and a rotation within industries is in motion.
As always, speak to your financial pros to see how these changes may affect your particular situation.