Analysis: A trillion-dollar wager that interest rates won't rise far
New York (Dec 2) - A build up of bets on rising interest rates has done nothing to derail a stock market rally based on conviction that policy tightening by the U.S. Federal Reserve and other central banks will go nowhere near as far as it did in the past.
A fresh bout of COVID-linked uncertainty has seen markets backtrack slightly on the hefty rate hikes priced in next year from the Fed, Bank of England and others. But Fed boss Jerome Powell's most recent comments indicate he is on track to raise rates several times in the next two years. read more
Stock markets have been mostly unfazed by rate rise talk - equity funds have seen inflows every week this year, save two. In a world where bonds, on an inflation-adjusted basis, yield far below 0%, there is simply no alternative, investors say.
And those negative "real" yields, alongside stubbornly low longer-dated government borrowing costs, flattening yield curves and soaring equities, all rely on the view that terminal rates - or where central bank policy rates will peak - will be lower than in previous cycles.
The previous Fed rate hike cycle peaked at 2.25%-2.5% in 2018. But the upcoming cycle will end below 2%, according to euro-dollar futures' view of U.S. rates in five years, a proxy for the terminal rate .
That bet, which is lower than the 2.5% the Fed itself projects, reflects the belief that policy tightening may end before interest rates hit the Fed's 2% inflation target. It implies "real" U.S. interest rates will remain negative.
It's a similar picture in the euro zone and Britain, where terminal rates are seen just above 0% and just below 1% respectively.
"What equity markets are saying (is) ... interest rates won't get very high and real yields will stay low," said Craig Inches, head of rates and cash at Royal London Asset Management.
"Bond markets are saying ... we will hold long-end yields low because we think (rates) will rise, then come straight back down again."
Reuters
