• The US 10-year US bond has risen 3%, inviting many views
• Rising yield – and declines – does have correlation with equity market
• The rise in bond rate should be seen from a yield curve perspective
• US equity market is struggling due to myriad of factors, not to rising yield

Is the 3% US bond rates the real problem?

A lot has been written about the recent rise in the 10-year US treasury rates (UST). Obviously several “journalistic analyses” have been pointing towards global doom that a 3% yield can bring about. A simple chart below demonstrates that there have been several occasions – and this is quite normal – for the US markets to rise in tandem with the 10 year yield or even fall with lower rates.

Based on the above chart we can conclude that a rising yield is not the main issue here. The US market has been impacted more by the following events. Firstly, the SP500 has quadrupled since 2009 until its record high in January 2018. So the UST is a convenient excuse for investors to sell on the back of soaring valuations in US stocks. Secondly, the US economy is now in its 9th year of expansion (or about 106 months), which if based on historical average a recession or a bubble usually occurs every 10 years or so. If we calculate the current US economic recovery from June 2009, then the next recession will possibly occur in 2019. The longest US economic expansion is 120 months, from 1991 to 2001.

To be sure, the US market can still decline further from now, but it will be driven by several factors, including trade war/tariffs which we believe is more damaging to global growth, earnings and inflation – not just rising yield.

Is the future an average of the past?

Basically, the yield curve compares interest rates at different maturities. Typically the spread between UST yields on 2-yr and 10-yr maturities are looked at to determine the yield curve, whether it is inverting, flattening or steepening. The 10-year UST yield historically has reflected the market’s growth and inflation outlook, while the short-end of the curve is mainly tied to market’s expectations for Federal Reserve policy rates.

The big question: Is a US recession forthcoming? Based on the yield curve shown below in chart 2, the answer is not yet. Although the UST spread between 10-yr and 2-yr is at its lowest in 10-years, the “inverted” predictor is not happening as yet. Is it concerning? Yes – especially if it continued the current trend of narrowing spreads. But from the last 2 occasions, yields can stay inverted for quite some time before a recession can occur.

Simply put, the yield curve is typically the steepest after recessions (short term rates are lowered stimulate activities, refer yellow circles in chart 2) and would invert when a recession is approaching (refer red circles Chart 2). Over the course of business cycle, yield curve tends to be flat as short term yields rise as Fed raises rates to keep inflation in check

In 2017, the yield curve flattened due primarily to a rise in the short term tenure. Although a flattening curve do sometimes flag for slower economic growth ahead, it also says something about expectations of a rise in Fed-induced rates outlook.

Recently, the yield curve has started to steepen as shown in chart 3, as the 10-yr UST has risen. This we believe is due to higher inflation outlook, US fiscal stimulus and a strengthening of the global economy, among other things, with the 10-yr UST rising to 3%.

Source: BIMB Securities Research - 26 Apr 2018