After nearly a decade of increasingly easy monetary policy, characterised by steadily declining central bank interest rates and quantitative easing (QE)– the printing of money to buy long-term bonds with the intent of reducing long-term yields - the major central banks around the world have started to tighten monetary policy.
Since September 2017, the Federal Reserve has put a stop to QE and simultaneously increased the cash rate from 1.25% to 2.25%. If the purpose of QE was to reduce the cost of debt (bond yields) to stimulate corporate activity, then it should be expected that the reverse with place upward pressures on the 10-yr US bond yield, which has now increased from 2.33% to 3.17% in the last 12-months.
As bond yields have fallen over the past decade, cheaper access to debt has seen the valuations of risk assets around the globe skyrocket (i.e. Australian Property). The reverse of this trend creates the possibility that risk assets will ‘re-rate’ to their prior valuation metrics, increasing the susceptibility of markets to sudden moves in bond yields.
Twice in 2018, 10-year US bond yields have increased by over 30bps (0.3%) in a 5-week period, with each move followed by a pull-back in global equities (see shaded boxes below). Following the January sell-off, markets traded sideways as investors digested the implications of higher rates before continued strong corporate earnings drove the market to new highs. We expect the continued strength of the US economy to result in a similar outcome.