MFS global investment strategist, Robert Almeida, has joined a growing chorus of market participants calling the end of the negative rates era with a “day of reckoning” ahead for risk assets.
In a note penned last week, Almeida says while the widely expected impending burst of inflation is likely to prove “transitory”, real interest rates are still poised to claw into the black after years of central bank-imposed negativity.
“… we’re confident that negative real rates are unsustainable and will eventually normalize,” he says. “What we’re less confident about is the timing or the rate at which real yields will rise.”
Almeida says the link between negative real US yields and rising equity markets since the depth of the COVID-19 panic last March is likely “causal and not coincidental”.
And as the trend reverses risk assets will inevitably reprice to reflect the positive yield environment.
“Since rates are the first hurdle in the valuation of any asset, higher rates, whether real or nominal, lower the value of that asset,” Almeida says.
US real interest rates hovered between 0 and 1 per cent since 2016 before falling deeply into negative space (currently about – 1 per cent) post the coronavirus crisis.
“In the years leading up to the pandemic, the real yield on the 10-year US Treasury Note lived in a meager range below 1%, but at least it was positive and provided investors with some sort of measuring stick,” Almeida says.
Understandably, he says equity markets surged as the US central bank (and most others) cut the traditional “anchor” of positive real rates.
“Since capitalism requires a hurdle rate, business schools or CFA prep courses don’t teach students how to value a company or a project with negative nominal or real interest rates,” the MFS note says.
But while CFA equations may have been non-functional over the last 12 months, the maths would come in useful again, Almeida says.
“Regime shifts are always clear in hindsight but rarely at the point of inflection, yet markets have a way of sniffing them out,” he says. “And when they do, we suspect that the relationship [between rising US share markets and falling rates]… will reverse as rising real yields undermine equity valuations. As we go from forecast to fact, we believe market performance and leadership will look materially different than they have in the past several quarters.”
The US Federal Reserve has committed to keeping rates low and quantitative easing measures in place for some time although there are cracks showing in the central bank facade.
Last week the Reserve Bank of NZ (RBNZ), for example, sparked excitement with a more upbeat stance, plotting a rise in the official cash rate from its current 0.25 per cent next year and a steeper-than-expected rise to 1.75 per cent by 2024.
However, RBNZ governor, Adrian Orr, emphasised the projected rate rises were subject to much uncertainty, noting the monetary policies required “considerable time and patience”.