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Yields on the 2-year Treasuries briefly exceeded those on the 10-year Yesterday, a first since 2019, a sign that bond investors are pessimistic about the long-term outlook. Historically, inverting yield curve, an abnormal state, did lead to recessions in the US as Fed officials pursued an aggressive tightening policy to combat inflation. But it is important to note that the inverting yield curve by itself has not been the catalyst for a drop in equity markets. Consequently, while yesterday's move is rare in its kind, it does not necessarily represent a threat to stocks in the near term.  

Rising uncertainty as a result of the widening conflict in Europe is sending investors to reassess the potential for interest rates to rise. In the last 24 hours, US 10-year treasury yields have dropped 10bp to 1.73%, a big drop from the level of 2.05% reached just 2 weeks ago, prior to the Russian invasion of Ukraine. Traders are bracing for more persistent uncertainty to affect not only the US Federal Reserve but also the European Central Bank. German 10-year bond yields are back in negative territory for the first time in a month. The two-year German yield has now slumped to -0.63%. Lower long-term yields are expected to be a net positive for long-duration risky assets, most often found in growth stocks. The big picture improves for stocks overall given their relative attractiveness versus the government bonds.

Bond prices are rising as geopolitical concerns ease, and traders are taking a step back from betting the Fed will start its hiking cycle next month with a 50bps move. Overnight swap data show odds of a 50bps rate hike dropping back to about 33%, levels seen before February US CPI print which came in at 7.5% yoy. Yesterday, the Federal Reserve minutes showed a rate hike could come as soon as March, though there was no indication whether it would be 25bps or 50bps. Officials showed concern about inflation spreading beyond pandemic-affected sectors, but also urged for a measured approach. 

Markets are witnessing challenging times in early 2022, as the risk of rising interest rates from major central banks has reached elevated levels. Wall Street analysts also for once seem not to agree on the outlook; while some believe markets have already priced in future likely central bank hikes, others are more cautious and point to possible weaker-than-expected demand which could negatively impact companies bottom lines. The good news is that opportunities arise when there's fear in the markets. Given the recent strong earnings reports, strong labor market, and still favourable financing conditions, It's very likely that stocks keep producing better returns than bonds. In fact, the equity risk premium in Europe (Stoxx600 earning yield minus the 10-year bund yield) is reaching very attractive levels, compared to both its past and US equities.  

The economic recovery has led to investors now pricing in the first Fed rate hike in the second quarter of 2022 and 3 hikes by the end of 2022. 1, 2, and 3 year Treasury yields have risen to their highest levels since the start of the pandemic. Financials with large cash deposits should be the main beneficiaries of rising Treasury yields. Chart by Charlie Bilello.