Analysis: With war risk, it’s unclear to what extent the collapse in US real yield will benefit equities

The Federal Reserve Building is pictured in Washington, DC, U.S. August 22, 2018. REUTERS/Chris Wattie/File Photo

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NEW YORK, March 7 (Reuters) – Real yields in the U.S. Treasury market have turned even more negative amid soaring inflation, generally seen as a positive for equities, but the invasion of Ukraine by Russia has placed more emphasis on reducing risk than on the possibility of obtaining higher returns on Wall Street.

Falling benchmark U.S. real yields, which have mostly been below zero since 2019, suggested investors are piling into TIPS on concerns about high inflation. Indeed, the war propelled the global Brent futures benchmark to a roughly 14-year high, at just under $140 a barrel.

U.S. stocks, even with a solid earnings outlook and backed by a robust economy, may not be the best asset to hold during this geopolitical crisis, analysts said, although there was some divergence in views.

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“If all else is equal and you sat there and saw that one of the greatest countries in the world attacked a country a third of its size and aspired to reconstitute the old empire Russian, is it really a good backdrop for stocks?” said David Petrosinelli, managing director and principal trader at broker-dealer InspereX in New York.

Russian President Vladimir Putin, brushing aside global condemnation of the invasion, which Russia calls a ‘special operation’, pledged to continue his offensive, which he said was going to be planned, unless Kyiv surrenders . Read more

Since Russia launched the invasion on Feb. 24, the yield on 10-year U.S. Treasury Inflation-Protected Securities (TIPS), also called a real yield because it excludes inflation, has fallen about 45 points. basic.

The 10-year TIPS yield has fallen about 64 basis points since the February 10 release of US consumer price data showing annual US inflation for January hit a 40-year high. On Monday, the 10-year real yield fell to -1.027%, its lowest in two months.

Follow each other’s movements

Real yields are an important part of broader financial conditions, and when they’re low, that’s generally supportive for US equities.

“Stocks, like many financial assets, are valued at the present value of their expected future cash flows,” said Tim Wessler, macro strategist at Deutsche Bank in New York.

“When real yields go down, that means the expected value of a stock’s future cash flows is going to be higher. If you look at the sector allocation of stocks, if you look at the S&P 500 and compare its returns to the big tech stocks or FANG stocks, they outperform the S&P on days when real yields fall,” he added, referring to Facebook’s growth stock pool (FB.O), now known as Meta, Amazon, Netflix and Google-parent Alphabet (GOOGL.O).

After a steep fall at the start of the year accelerated by Russian-Ukrainian tensions, the benchmark S&P 500 index (.SPX) rebounded about 4% from its February 24 intraday low. But Wall Street’s fear index, the VIX, (.VIX) spiked and the market sold off late last week and opened on Monday.

The S&P 500 Technology Index (.SPLRCT) fell slightly last week, mainly due to selling on Thursday and Friday. Since its intraday low on February 24, this index has actually gained 4.2%.

Analysts said that apart from falling real yields, US equities have benefited from the idea that the latest geopolitical turmoil means the Federal Reserve will take a gradual approach to tightening monetary policy, starting next week. .

Fed Chairman Jerome Powell said last week he would support an initial quarter-percentage-point hike in the Fed’s benchmark rate at the March 15-16 meeting, but hinted the prospect of a more aggressive hike this year if inflation does not slow. Read more

“This uncertainty is going to cause the Fed to move slower, to tighten more slowly, and as a result, to fall behind the inflation curve, which is positive for risk assets and support for them,” Fixed income strategist Ryan Swift told BCA Research in Montreal.

InspereX’s Petrosinelli, however, thinks the risk in equities is medium to long term.

“The expectation component is really the wild card here,” Petrosinelli said. “We could be sitting at $150 a barrel oil very, very easily here in the next few days and I’m not saying that’s going to happen. But that can’t be good for equities.”

Price spike
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Reporting by Gertrude Chavez-Dreyfuss; Additional reporting by Lewis Krauskopf; Editing by Alden Bentley and Nick Zieminski

Our standards: The Thomson Reuters Trust Principles.

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