Assets that Will Suffer on the Return to the Normal Interest Rate Regime
$SPY, $GLD, $SLV, $BAC
While Treasuries faded a bit after 10-year yields tapped at the 3% mark last week for the 1st time in 4 years, expectations are mounting that higher rates will soon be normal again, that rate historically is 5.0%
US Treasuries began this week higher
2-yr Unch at 2.48%
5-yr -1 bpt to 2.79%
10-yr -2 bpts to 2.94%
30-yr -3 bpts to 3.10%
Below is a rundown of what assets stand to suffer as interest rates rise to the historical norm at 5.0%.
The S&P 500 Index has had a moderately positive correlation with the 10-year yield for most of the time since 2000, though a look beneath the surface shows a sharp divergence among sectors.
Utilities look to be most at risk, going by the XLU ETF (exchange-traded fund). It has had a correlation of around -0.3 with 10-year yields for the past 6 months. If rates resume their upward march, the power companies could head the opposite direction.
Real-estate firms with high payouts have also served as bond proxies, so continued weakness in Treasuries would likely see investors flee from REITs.
The correlation between the 10-year and the S&P 500 Real Estate Sector GICS Index went to -0.5 in February 2017, and now sits around -0.1.
Gold has been negatively correlated with yields for years, the magnitude has been coming in for several months now. So, while the correlation hit -0.6 in late September, it is now less than -0.2.
Silver’s chart does not look different, with the correlation now at -0.15.
Higher inflation mean higher precious metals prices.
Emerging-market bonds may take a hit, as their correlation with the 10-year yield as measured by the ETF with ticker EMB is at -0.13 right now, but spent some time below -0.60 in Y 2017.
Higher-duration junk bonds are exposed to risk from rising 10-year yields, so they could take a hit. Rising rates also boost the appeal of investment-grade corporate bonds at least for the time being, according to a high-grade bond strategist at Bank of America Merrill Lynch.
It is a different story for leveraged loans and municipal bonds.
The sweet spot is 3% for leveraged loans, which have coasted higher on a demand-supply imbalance. And as US Treasuries rise, municipal investors will likely earn higher yields on new state and local debt, a potential draw to buyers, even though the value of any bonds they currently hold will decline.
Indicators from the broader economy will be in focus.
These will be interesting because they have not necessarily had a negative correlation with US Treasury yields in recent months as the economy has grown, stocks have risen and consumer confidence has climbed, but could also reverse quickly if signs of strain develop.
Watch housing and autos, credit card usage and business loans in the context of potential higher rates.
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