Are Rising Yields Going to Spoil the Bullish Party?

February 23, 2021 at 09:11 PM

US yields are seeing another day of highs. The US 10-year yield rose to fresh cycle highs on Monday and was trading slightly below the 1.4% handle as traders keep dumping bonds due to inflation expectations. 

Based on Federal Reserve (Fed) funds futures markets, the chances of a 0.25% Fed rate hike by the end of 2022 have increased from 50% to 70%. The same market sees a 95% chance that if the rate hike doesn’t take place in 2022, it will by March of 2023. 

At the same time, economists have been rapidly increasing their 2021 Gross Domestic Product (GDP) forecasts. The majority of them now expect the US economy to grow by 5% in 2021 as lockdowns ease and people return to their normal lives.

However, it’s not that simple. Stronger economic growth could prompt a faster rise in rates, driving up borrowing costs and weighing on risky assets such as stocks and high-yield bonds, limiting economic growth.

It looks like equities are starting to roll over; on Monday the tech-heavy NASDAQ 100 index saw its fifth day of decline. Tech, growth and small-cap stocks are usually hit the hardest by rising rates. 

And since stocks can only go up, as the favorite mantra goes, the Fed needs to step in soon and start doing something to stop the rise in yields. Otherwise, we can really experience a larger correction. 

Another sign of a waning bullish mood could be from the hedge funds’ positioning as they turned short on small caps two weeks ago, then widened their bearish bets a week later. As of Friday, their net short exposure, at 9,000 contracts, is the largest in eight months.

Additionally, it seems that rising yields are not helping the USD as inflation expectations continue to rise. At least something “good” came out of it for foreign investors. 

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