Yields are trending down again

Since the beginning of the year, the continued acceleration in inflation has caused central banks to sound increasingly hawkish, which has pushed US 10-year Treasury yields sharply higher. This has triggered one of the worst total return performances since the start of the year and caused panic in the stock markets. The mechanism also works in reverse, driving valuations higher when yields fall, as they have over the past three weeks.

The 10-year yield has fallen to 2.74% since Friday after hitting a multi-year high of 3.13% on May 6. It rose to this level as investors sold fixed income, arguing that the Federal Reserve would soon begin reducing the huge holdings of bonds it has built up over the years in its efforts to stimulate the economy .

The recent fall in yield is not just any fall. The recent move takes the number below a key level, the around 3% it reached in late 2018 before a long decline began. In terms of technical analysis, the fact that returns have not exceeded 2018 levels means that this is now less likely.

In fact, in no Fed tightening cycle in the last 40 years have 10-year Treasury yields surpassed the high from the previous tightening cycle. In other words, that could be it for the recent surge in Treasury yields. We won’t know for sure in a few months, but it’s possible that Treasury yields will fall as inflation settles and the economy slows, which is what the Fed wants. Data released last Friday showed that PCE core inflation, the Fed’s preferred measure of inflation, fell to 4.9% year on year in April, the lowest level in four months, suggesting inflation may be slowing.

Importantly, yields are now high enough at current levels to attract buyers of 10-year debt. At 2.74%, the yield is above the 2.5% average annual inflation that the market seems to be expecting over the next decade. That means investors can now earn a real, inflation-adjusted return by owning the bond. More buyers would keep the price higher and the yield lower.

Growth stocks are already beginning to benefit from the perception that the rise in yields may have ended. As the broader market recovered from a May 11 low, exchange-traded fund Russell 2000 Growth (Ticker: IWO) is up 11.1%, doubling gains from the S&P 500 and beating other major U.S. indices.

Growth stocks are highly valued because investors expect them to provide increasing earnings for years to come. As long-term debt yields rise, the present, discounted value of that future yield falls, making investors less willing to pay. The hope is that price-to-earnings ratios for these stocks will fall, which would allow earnings growth to lift their prices.

Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The item is issued by Calamatta Cuschieri Investment Services Ltd and is authorized by the MFSA to conduct investment services business under the Investment Services Act and is also registered as a tied intermediary under the Insurance Distribution Act 2018.

For more information, see The information, views and opinions contained in this article are provided for educational and informational purposes only and should not be construed as investment advice, advice regarding any particular investment or investment decision, or tax or legal advice.

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