Rising rates make the safety of bonds look more appealing, and they put a dent in stocks and cryptocurrencies, among other risk assets.
Rising interest rates have put a major dent into risk assets, from stocks to cryptocurrencies to high-yield bonds, and there may be more to come.
The 10-year Treasury yield has risen 0.2 percentage point so far this year, to 1.71%.
The culprit behind the yield increase is raging inflation. Consumer prices soared 7% last year, and that has led to a consensus that the Federal Reserve will lift interest rates at least three times this year, likely starting in March.
Higher rates often can lead to higher stock prices because the rates result from strong economic growth. But so far the stock market isn’t looking at it this way. The S&P 500 index has lost 10% year to date.
One reason high rates are hurting is that low rates have been a major factor pushing investors to stocks in recent years, as low yields make bonds unappealing. Many analysts have cited low rates as a justification for historically high stock valuations.
As of Jan. 13, the forward 12-month price-to-earnings multiple for the S&P 500 was 21.1, well above the five-year average of 18.5 and the 10-year average of 16.7. Higher rates take away the support for that outsized valuation.
Rising rates have hit technology stocks particularly hard. The riskiness of tech stock returns becomes more of an issue when the safer investment of bonds offers higher yields than before.
Moreover, “in the tech sector, which tends to trade at a very high valuation, there are lots of new companies that have debt and leverage,” Randy Frederick, director of trading and derivatives at Schwab Center for Financial Research, told CNBC.
Those tech companies could face a cash crunch “because when that debt expires, it will have to be replaced at a higher rate,” he said.
Rising interest rates haven’t been good to cryptocurrencies either, as investors shy away from risk.
Bitcoin has sunk 28% so far this year, recently trading at $34,195. Another speculative investment taking it on the chin is junk bonds. The ICE Bank of America U.S. High Yield Index had an effective yield of 4.8% Friday, up 0.45 percentage point so far this year.
Coming Fed rate hikes and shrinkage of the central bank’s balance sheet could mean further pain for stocks and other risk assets.
“The scale of what they’re contemplating now is completely unprecedented,” Janice Eberly, a former Treasury Department official who’s now a finance professor at Northwestern University, told Bloomberg.
“It’s prudent to gauge the market reaction, especially before moving the balance sheet in concert with interest-rate changes.”
