Marketmind: It's getting real

BY Reuters | TREASURY | 01/10/22 03:09 AM EST

A look at the day ahead from Sujata Rao.

As markets move to price a U.S. interest rate liftoff, possibly even from March, 10-year Treasury yields have risen a quarter point since the year started. Even more interestingly, "real", or inflation-adjusted U.S. yields are driving the moves with a 33 basis-point jump.

Real yields, while at the highest since last June, will remain deeply negative for a while. But their rise poses challenges for assets that benefited from the there-is-no-alternative reasoning. The past week saw stocks wobble, bitcoin tumble 8% and Nasdaq tech, the quintessential low-rate play, fell 4.5%. Graphic: Real yields, https://fingfx.thomsonreuters.com/gfx/mkt/egvbkjowdpq/Pasted%20image%201641767281191.png

Holders of longer-duration bonds are also likely nervous -- such assets saw big outflows in the past four weeks, Goldman Sachs notes.

Meanwhile, inflation isn't letting up; euro area prices rose 5% year-on-year in December and Wednesday's U.S. CPI reading is expected at 7%-plus. The ECB has stayed resolutely dovish however -- board member Isabel Schnabel did say on the weekend the bank may need to act if energy price rises prove persistent. The euro started Monday 0.3% lower.

Stocks are trying to claw their way back up -- U.S. and European equity futures are inching up even if Treasury yields, both real and nominal, are a touch higher.

So what happens to stocks if real yields continue rising? There have been episodes a-plenty when equities rose alongside real yields, most recently in the March 2020-February 2021 period when a 1.5 percentage real yield increase was accompanied by a 50% global equities return.

Noting this, Berenberg recently advised clients to stay put. The share of rate-sensitive tech however is now far higher than in the past which possibly changes the equation a bit.

Finally, let's not forget the worrying geopolitics and fast-spreading Omicron, both capable of adding to inflation and dampening economic growth. Oil prices are extending last week's 5% gain and U.S.-Russia talks look set to start later in the day with few expectations.

Key developments that should provide more direction to markets on Monday:

-German Finance Minister Christian Lindner and Paschal Donohoe, Eurogroup president hold press conference

-NATO head Jens Stoltenberg meets with Ukrainian Foreign Minister

- Kazakh president steps up purge of security agency

-No concessions, no breakthroughs: Russia, U.S. cast pall on Ukraine talks

-Evergrande onshore bondholders to decide on extension; fellow developer Shimao puts all projects on sale

-UK manufacturers positive about 2022

(Reporting by Sujata Rao; editing by Danilo Masoni)

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully.

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