Bond Yields Get Real

By Nicholas Jasinski |  Friday, April 22 Selloff. Stocks extended yesterday's slide today, finishing at their worst levels of the session. The bloodletting was widespread: All but 15 S&P 500 components finished the day in the red. The index's 11 sectors all fell at least 1.5%. The Dow Jones Industrial Average dropped nearly 1,000 points, or 2.8%, for its greatest one-day decline since 2020. The S&P 500 shed 2.8%, and the Nasdaq Composite lost 2.5%. The trigger for the sharp declines was the latest tick higher in bond yields. That's not a new narrative or trend, of course. Bond yields have been steadily climbing since last fall.  But, as Barron's Randall W. Forsyth explains in this weekend's Up And Down Wall Street column, it's about the neighborhood that bond yields' rise has recently taken them into. The 10-year U.S. Treasury yield is flirting with 3%, levels not seen since 2018. And, even more important, the note's real—or inflation-adjusted—yield touched zero percent this past week, for the first time since the early weeks of the pandemic. Randy explains the significance: The concept of real interest rates was developed by economist Irving Fisher more than a century ago. The nominal rate quoted on an instrument consists of a real rate, plus the anticipated inflation over the instrument’s life. Expected inflation is reflected in the “break-even rate,” calculated by deducting the real yield on Treasury inflation-protected securities from the regular Treasury note’s yield. For a while Tuesday, 10-year TIPS traded at a 0% real yield, while the 10-year Treasury was quoted at 2.93%, which means the anticipated break-even inflation rate was 2.93%. Back on March 7, the 10-year note yielded 1.78% while the corresponding TIPS changed hands at negative 0.99%, for a break-even inflation rate of 2.77%. So, the recent jump in the Treasury yield was almost all in its real yield. Positive real interest rates are associated with more-restrictive financial conditions, which is what the Fed is trying to promote to curb inflation. Negative real rates are almost a bribe to borrowers, who can invest money cheaply obtained in all manner of things, wise and otherwise, pumping up asset prices. The process works in reverse when real rates rise and turn positive. In other words, bond yields are finally getting real. We're getting to the point where monetary policy is prompting changes in markets that will actually start to restrict economic activity—not just introduce incrementally less stimulus. But so far that has all been reflected in bond market pricing, not the Federal Reserve's benchmark interest rate target, which remains at just at 0.25%-0.50%, far below the 10-year yield. It's when the federal-funds rate and the 10-year yield are in the same neighborhood that policy really, actually begins to become restrictive. "Right now, they not even in the same ZIP Code," Randy writes. For now. Read the rest of this weekend's Up And Down Wall Street column here. Watch our weekly TV show on Fox Business Saturday or Sunday at 10 a.m. or 11:30 a.m. ET. This week, an interview with White House economist Jared Bernstein.

 

Review & Preview is saying farewell to Barron's features editor Jeffrey Cane today, who is moving on to a new opportunity. Jeff has been with R&P since the beginning and has left a major mark on the newsletter. The R&P team and the entire Barron's newsroom will miss him. Best of luck Jeff! DJIA: -2.82% to 33,811.40 S&P 500: -2.77% to 4,271.78 Nasdaq: -2.55% to 12,839.29 The Hot Stock: Kimberly-Clark +8.1% The Biggest Loser: HCA Healthcare -21.8% Best Sector:  Consumer Staples -1.6% Worst Sector: Materials -3.7%