Tapering, Bond Sell-Off: It’s For Real says GoldmanVW Staff
Treasuries fell to 13 month lows on fears of tapering by the Fed.
Bonds, tapering and the fear factor via Goldman Sachs. See their presentation with lots of charts on Tapering here.
Ben Bernanke’s recent comments have ignited concern about an earlier move to tapering of bond purchases by the Fed. This has also been associated with a sharp sell-off in bonds with US 10-year treasuries up 50bp in a month. While there are certainly risks around QE being withdrawn we continue to view rising bond yields as relatively benign for European equities. Indeed provided it is better growth that is driving yields upwards (which is what we expect) we would argue it is supportive. We find a positive relationship between real yields in the US and European equities.
Fed tapering and comparisons with 1994
Our economists continue to expect the first hike in the Fed funds rate to occur in early 2016 with the FOMC to start tapering QE in 1Q 2014. Such a move after a prolonged period of rising purchases has the danger of derailing the recent equity rally. A surprise rise in Fed funds in 1994 did just that; European equities sold off 17% over the following months.
Equity market less vulnerable today
1994 saw a much sharper rise in bond yields and moreover the equity market was more vulnerable than today. European equities had risen by 42% in the previous year and were on a P/E of 17x (a 40% premium to the previous 5 years). Today the market is up 27% over the last year, on a P/E of 12x and at only a 13% premium to the 5-year average. We still see the most likely outcome as a modest rise in bond yields and reasonable returns on equities. Rising yields and a steepening curve should benefit cyclicals over more defensive sectors; telecoms and food/beverages have typically had the most negative correlation with yields in recent years.
Bonds, tapering and the fear factor
We’ve highlighted before that rising bond yields – from relatively low levels – tend to be a positive for equities. As shown in Exhibit 1 the correlation between European equity market performance and moves in the bond yield has been positive since 1999. Higher yields have been synonymous with stronger growth (good for equities) while lower yields have been associated with both weakening growth and rising chances of deflation – both poor outcomes for equities. See Strategy Matters: Breaking the bond barrier: Impact of rising bond yields on equities, February 14, 2013.
Prior to 1999 the reverse was true; rising bond yields were generally seen as a negative. We attribute this shift in the relationship largely to the level of bond yields and therefore whether there is more to fear from weak growth and deflation (the case in recent years) or from high growth leading to inflationary concerns.
As shown on the scatter plot below we’ve found in the past that whenever bond yields are below 4-5% the relationship between moves in yields and equities has been a positive one. The current two years of data fits well with this.
Further Reading Quantitative Easing: Easy in, but Very Hard out [ANALYSIS]
Full presentation below: