Vaccine-led rise in bond yields ripples through markets
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Pfizer’s announcement that its Covid-19 vaccine was more than 90 per cent effective in preventing the virus behind the global pandemic has been hailed by some analysts as a “game changer” for the global economy.
The jump in long-term interest rates that followed the news on Monday could also be a game changer for global equity and credit markets.
Investors were immediately dusting off the “reflation trade” that many had pursued before the US presidential election: the idea that a second major fiscal stimulus would boost the American economy and feed through to inflation. This had been put on hold after Democrats looked likely to fall short of a Senate majority, stymieing president-elect Joe Biden’s agenda and the prospects of an aggressive fiscal injection.
Instead, the prospect of a vaccine, developed by Pfizer and Germany’s BioNTech, once again shifted the outlook.
Investors moved out of government debt, pushing the yield on the 10-year Treasury note, which had traded around 0.82 per cent on Friday, to as high as 0.97 per cent on Monday — a level it last reached in March.
“This was the vaccine moment the rates market had waited for,” wrote analysts at ING in a note. The 10-year Treasury was largely steady on Tuesday at 0.95 per cent by mid-morning in New York.
“A vaccine with a greater than 90 per cent efficacy rate is another form of stimulus that you have to weigh in,” said Bob Michele, chief investment officer at JPMorgan Asset Management. He said it could ultimately catapult the 10-year Treasury yield up to about 1.25 per cent.
An early question for investors is how damaging a big jump in long-term yields might be to the valuation of technology stocks. While the broad market was up strongly on Monday, the tech-heavy Nasdaq 100 index fell 2.2 cent, with hot “momentum” stocks such as Zoom Video Communications, PayPal and Netflix among the biggest losers. The index lost another 1 per cent in early trading on Tuesday.
Ultra-low bond yields have burnished the lustre of growth stocks this year. The lower bond yields are, the more investors should be willing to pay for stocks with strong growth prospects, according to most valuation models.
With momentum and growth stocks suddenly out of favour, the biggest winners on Monday were so-called value stocks, cheap securities often found in economically-sensitive industries that have been shunned by investors this year. The Russell 1000 Value index, which has been struggling for more than a decade, jumped more than 4 per cent. It crept higher still in early trading on Tuesday.
For Jonathan Golub, chief US equity strategist at Credit Suisse, the question on investors’ minds is just how long the rotation away from growth companies and into value stocks will last.
“In the long term these growth companies are better companies, but it doesn’t mean you don’t have powerful value runs,” he said. However, “every one we’ve had [recently] has rolled over and died”.
Mr Golub thinks this time could be different, with investors favouring value stocks for several weeks or even months, but the outcome will hinge in large part on where Treasury yields go from here.
“In order for the rotation into value to continue, you really do need interest rates to go higher,” he said.
Mr Michele argued that the US central bank was unlikely to let Treasury yields rise significantly, given the potential financial damage.
“This can only go as far as the Fed is willing to let it go,” he said. “They are not going to let it go crazy because that could derail the recovery.”
The Treasury market jolt also threatens to raise borrowing costs for corporate America.
Blue-chip company bonds fell sharply on Monday, with a widely-watched investment-grade bond exchange traded fund known by its ticker LQD sinking 0.8 per cent, its largest one-day loss since early September.
High-yield bonds jumped, however, as investors bet that a quicker economic revival would be good for the creditworthiness of heavily-indebted companies — including those in the travel and leisure industries that have been forced to borrow to survive the pandemic.
Corporate debt issuance continued apace on Monday, with yield-hungry investors lapping up debt sales from nine investment-grade companies, according to people familiar with the deals.
Pharmaceuticals group Bristol-Myers Squibb pitched a $7bn offering across six different maturities and its 10-year bond was met with high demand, allowing the company to reduce the interest rate it offered from a spread of 0.8 percentage points over the equivalent US Treasury to 0.55 percentage points.
“The market continues to function extremely well,” said Jim Shepard, who runs investment-grade bond issuance at Mizuho in New York. “There is just a ton of cash sloshing around the market.”
Some analysts warned that investors may be overreacting to the news released by Pfizer, which they said should have been anticipated and is hardly the final word on a Covid-19 vaccine. Several drug developers are pursuing promising late-stage vaccine trials, and it will still take time for an effective jab to be widely available.
“If you look at the changes we’ve seen in markets today it’s like it’s all done and dusted, the pandemic never existed,” said Luca Paolini, chief strategist at Pictet Asset Management.
“But considering we are following on from such a strong week, the reaction looks a little bit extreme. It's not as if there was no prospect of a vaccine before today.”
Additional reporting by Tommy Stubbington in London