As at 4 August 2023
Over the several months, long-term bond yields in the US have moved steadily higher, with the 10-year approaching a 15-year high of 4.2% at the time of writing. This last marks a complete reversal of the decline in long-term interest rates seen after the collapse of Silicon Valley Bank in March of this year, which sent the 10-year below 3.5%. Interestingly, unlike the surge in interest rates seen during 2022, these recent moves do not seem to be driven primarily by inflation data, which has come in lower than expected in the past several releases. Moreover, whilst short-term yields tended move more than their long-term counterparts last year, this has now reversed.
Title: US 10-year Yield, Cumulative Percentage Point Change¹
Source: Fulcrum Asset Management
Through our internal modelling of asset prices, we aim to give a structural economic interpretation to developments in financial markets. This involves decomposing price movements into contributions from fundamental economic shocks, which are mutually independent of one another and have a strong basis in economic theory. Using a Bayesian Structural Vector Auto-Regression (SVAR) with sign and narrative restrictions, the model identifies 8 separate shocks: Monetary Policy (MP), Unconventional Monetary Policy (UMP), risk sentiment (RISK), oil supply (OIL), Domestic Demand (DD), Global Demand (GD), aggregate supply (SUPPLY) and an unknown shock (RESIDUAL). The chart shows the contribution of each of these shocks to the cumulative change in 10-year yields since the 5th of May. We see that the largest single contributor has been the UMP shock, which is identified as a shock that pushes interest rates upwards and steepens the yield curve. Notably, the contribution from this shock saw a significant increase in the last week alone. However, a significant portion of the move has been led by improving economic sentiment (signified by the blue and dark blue bars), which is consistent with the recent strength in US economic activity. Moreover, risk-on market tone has also pushed yields higher, as shown by the red bar.
As we have shown, a large part of the recent moves seems to be led by ‘true’ policy tightening, which, all else equal, should put pressure on broader asset prices. However, a not inconsiderable amount of the rise seems to have been led by improving economic and market fundamentals, which, all else equal, should provide a boost to valuations across markets. As such, it is important to bear in mind not just the movements in long-term interest rates, but also the causes of these, for, as we have seen, different causes may have very different implications for the wider investment universe.