The sharp rise in borrowing costs has raised justified alarm but there are benefits too. First, we suspect that stronger growth is driving yields higher rather than increased inflation risk or policy uncertainty. Accelerating AI-related capital expenditure is both boosting economic growth and, likely, pushing real yields higher.
Increased government spending on areas such as defence and infrastructure may also be boosting real growth and real rates — especially as some of this economic growth is coming from falling household sector savings across the G7 group of nations. Second, investors should welcome the fact that higher real yields are a source of capital discipline on both governments and corporates. Moreover, this additional discipline need not necessarily constrain the level of capex.
Despite what economic theory would suggest, real yields and corporate capex have tended to broadly rise and fall together over the past 40 years. More importantly, these higher real yields are also likely to lead to more productive capex. Third, higher real yields will probably see less financial engineering driving markets, which should boost investor and policymaker confidence in the longer-term stability of the financial system.
Non-bank financial institutions such as private capital firms were key beneficiaries of the QE period, in part because cheap funding facilitated increased financial engineering. This helped NBFIs to displace the more regulated, traditional bank lending. We are already seeing a reversal in the fortunes of listed US non-bank stocks compared with US bank stocks, as real rates have normalised.
Finally, higher bond yields may create more options for long-run asset allocators. The AI bubble has meant that, for many, investing in US equities has been the “only game in town”. This could be changing.
Rapidly rising bond yields have often been a precursor to market corrections, as they expose the extent to which the gains in the stock market have been driven by higher valuation multiples, rather than the growth in earnings, or dividends.
Source: Financial Times Markets · Summarized by HeadlinesBriefing