Fed fallout spreads as move to raise US rates begins to rattle markets

Are we there yet? It’s a reasonable question for bond investors after a historic downward swing in government bond prices to reflect the US Federal Reserve’s increasingly aggressive tilt.

Unfortunately for those of you licking your wounds, the short answer is “probably not.” In fact, judging by this week’s swings, the market shakeout is just beginning.

Central bankers are not sadists. Those who intend to raise rates to combat inflation want to try and do so without causing undue financial market instability or, worse, economic downturns. But the path back to higher interest rates is inevitably bumpy.

As Joseph Amato, director of equities investment at Neuberger Berman, puts it: “When the Fed hits the brakes, somebody goes through the windshield.” Assets caught without a seatbelt this week include Netflix stock, the Japanese yen, and the Chinese renminbi. More will follow.

The scale of the change in government bond markets is something to behold. Charles-Henry Monchau, chief investment officer at Bank Syz, said the first three months of the year were “emotional and difficult for investors”. Long-term US government bonds were already on track for their biggest annual decline on record dating back to 1973, even before Fed Chairman Jay Powell raised expectations this week of a sharp half percentage point increase in interest rates next month.

Prices have fallen so fast that benchmark 10-year Treasury yields are hovering near 3 percent. At 2.9 percent, they are already at their highest point since 2018.

Even after eight years, we are seeing the end of the upside-down era of negative bond yields. Investors, largely reluctantly, have become accustomed to buying bonds in the full knowledge and certainty that they will lose money holding them to maturity, thanks to high prices and painfully low interest rates. Now the total global debt of $11 trillion (yes, trillion with at) has emerged from the deep freeze of negative yields. Only a relatively modest $2.7 trillion remains. German 10-year bonds, always low or even negative, now yield 0.95 percent, the most since 2015.

On April 7, Barclays said enough is enough and recommended buying 10-year US Treasuries. Less than two weeks later, he walked off that call at a loss. It’s a tough time to be a bargain hunter.

It stands to reason that bond markets, the most interest-rate sensitive asset class, would react so strongly to central banks’ change of direction. But the ripple effect in other markets is now becoming clearer.

“We are all bond traders now,” currency analyst Kamal Sharma wrote at Bank of America this week. Major currencies are “dominated” by bond market moves this year, he said, with “one theme to rule them all.”

The Japanese yen clearly shows it. It has slumped to a two-decade low against the dollar due to the gap in stance between the Federal Reserve, which has made no secret of its plan to raise rates, and the Bank of Japan, which is determined to keep yields low. your bonuses. . Japanese officials generally like to keep the yen strong and weak to help support exports. In this case, however, the currency has fallen hard enough and fast enough (11 percent since early March!) that traders are on high alert for intervention to prop it up.

And it’s not just the yen; China’s renminbi has also fallen sharply, in part because US bond yields have slid to China’s level for the first time in 12 years. Some market participants are wondering if the Swiss franc could also catch the bug.

¥ per $ line chart showing yen languishing at 20-year low as Fed and BoJ policies diverge

But perhaps the clearest illustration of how the Fed has changed the game for investors came this week from Netflix, the streaming service that became a must-have while we were all cooped up in our homes, but is now a good thing to have. luxury as households try to cut costs. His stock price plummeted nearly 40 percent after he said he had lost customers and expected to lose more.

Netflix was one of the tech stocks that had already been tanking since the Fed first made its tightening intentions clear. But the last accident was spectacular from all points of view.

“I don’t know if it’s a sign of things to come,” says Neuberger Berman’s Amato. “I think it has already arrived.” Either way, the difference in today’s more nervous market environment is clear. “If you miss a number, if you miss a sales expectation, it’s a brutal price revision,” he says.

This market environment, with sky-high inflation and the real risk of further recessions, points to periods of volatility and calls for caution, he says.

Investors are, of course, aware of the story here. The so-called gradual tantrum of 2013, when the mere suggestion that the Fed would withdraw support for bond purchases put emerging-market assets through the woodchipper, is just the biggest and most recent example; rapid rate hikes in 1994 ended up bankrupting California’s Orange County and setting the stage for Mexico’s peso crisis.

We are still nowhere near that point. But the task for politicians to engineer a soft landing, without serious collateral damage, is a difficult one. The latest slip-ups offer a reminder that accidents can easily happen.

katie.martin@ft.com

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