The dominant market story of recent weeks has been the rise in US government bond yields and the implications for asset markets and policy makers. Longer-dated government yields have been gradually rising from a low base since the middle of last year, reflective of recovering growth and inflation prospects. However, with vaccine distribution well under way, fiscal policy on full-tilt and a savings fuelled spending boom expected later this year, 10-year yields have climbed above pre-pandemic levels to 1.60% and financial markets are now pricing a US rate hike as early as December 2022 in response an accelerating US economy. As rate expectations have shifted, so too have asset prices sensitive to US yields. The US Dollar has strengthened and we have seen weakness in investment grade bonds, emerging market stocks, gold and the US technology sector, which had previously enjoyed a subdued growth outlook and collapsing yields. At the same time, strong growth and firmer inflation expectations have triggered equity market rotations with cyclical sectors such as energy, financials and materials all benefiting.
Although financial market performance has been mixed recently, the move higher in US yields has been orderly and steadily absorbed by wider asset markets, that said the risk of a more volatile spill-over has led some market commentators to speculate on US Fed policy intervention. Nothing in recent communications from Fed officials suggests an intervention is imminent. The rise in yields has been viewed as a function of economic optimism, not inflation fears, and there has been no suggestion of a rate hike before 2023. At the time of writing, the March meeting of the US Federal Reserve (Fed) was about to get underway – the committee’s statement and accompanying forecasts will be keenly watched.