The 10-year and 30-year US yields are pushing towards the top of their trend channels. These interest rates are all-important for the further evolution of long-duration assets. 2 per cent on the 10-year segment seems to be a breaking point. A barbell strategy between value and growth may offer a solution.
It is a familiar phenomenon: long-duration assets, whose cash flows lie far in the future, have been discounted at extremely low interest rates in recent years. So these growth stocks, typically technology, have benefited excessively. But now long-term interest rates are rising and that is putting pressure on these stocks, as we saw yesterday in the US during the trading session on the Nasdaq, the worst in six months.
BNP Paribas Fortis chief strategist Philippe Gijsels (photo) said he finds it logical that interest rates are starting to rise. “After the Covid crisis, we initially saw a rise in interest rates. Perfectly explainable, but less logical was the fall afterwards. You see that interest rates start to rise with a delay. What often happens after Jackson Hole is that the hawks are sent out to bring a message of tapering. They are doves in disguise rather than real hawks. Powell then says that tapering will not be a big deal and interest rates relax again. But that story no longer seems to be catching on.”
Gijsels argued that the absurdly low interest rates are no longer in line with growth and inflation. “It is a very normal reaction, this rise in interest rates. We are still very far from where we should be. It also depends on the pain threshold of the Fed. Can it live with 2 per cent or even slightly above that on the 10-year segment? Look at what happened in 2018 between Christmas and New Year. The markets then corrected very sharply. Then the Fed adjusted its discourse and 2019 ended up being a fine stock market year. It is not inconceivable that we will end up in such a situation.”
ECB
In Europe, the story is quite different. After all, Lagarde has stated that the first interest rate increase is not in the pipeline before 2025. The PEPP emergency programme expires in mid-2022, but it could be replaced by another programme buying up paper at a rate of €20 billion a month.
Markets
Gijsels argued that the market reaction will be important for the stance the Fed will take. “If the markets correct further by 15 per cent, then you will see what happens. Then you end up with another rhetoric and it will be QE forever again. That poses a huge philosophical problem. The additional difficulty is inflation. Up to now, Powell has always claimed that inflation is a passing phenomenon, but yesterday his discourse began to crack and he cited some structural elements such as the sharp rise in energy prices. That raises the doomsday scenario of stagflation, which is at least not our base case scenario.”
For years there has been QE without leading to inflation, but the tide seems to be turning now. Gijsels put it as follows: “You are stuck on two sides as the Fed. You have to play growth and inflation, two variables, with one fixed element, namely interest rates. That is extremely difficult.”
Barbell
According to Gijsels, investors can therefore best set up a barbell strategy between growth and value. “The choice between both is extremely difficult, and at BNP we solve this in this way. You really want to be in technology for the long term. Never in human history have we had so many exponential growth prospects. But these long duration assets may struggle in the coming period. That is why it is best to bet on inflation- and interest-sensitive assets. There are huge gains in technology stocks and if interest rates rise further towards 2%, there could be further profit-taking. You have to take that into account.”