The U.S. 10 year Treasury yield peaked in early September, after rising most of the summer in anticipation of the Taper. The No Taper announcement on the Sept FOMC broke the multi-month uptrend in U.S. Treasury yields.
The 10 year yield is around 2.65% this morning, vs. a peak of about 3% in September. The 2.5% is the obvious level to watch on the 10 year yield, and importantly, it was not breached on the most recent decline in yields.
Stocks have clearly been reacting to moves in rates. The correlation between the 10 year yield and the S&P 500 has flipped in the past 6 months:
However, it’s worth noting that yields are substantially higher and the S&P 500 is also substantially higher in the last 6 months. How does that add up with the negative correlation?
When yields have moved higher, the selloffs in the S&P 500 have been of much smaller magnitude. When yields have moved lower, the rallies in the S&P 500 have been of much larger magnitude. So the correlation does not give us any sense of the magnitude of the moves.
Given the move higher in rates, which major sector in the U.S. has recently had the highest correlation to rate moves? On the negative side, high yielding sectors like REITs, Utilities, and Consumer Staples have generally been out of favor when rates rise. Two main potential reasons – 1) investors find the relative yield less attractive with higher overall interest rates; 2) investors are more interested in cyclical sector exposure, rather than historically defensive sectors, as rates are moving higher due to higher expected economic growth prospects.
Whatever the reason, REITs have been the hardest hit of the group. Here is the comparison of XLP, XLU, and IYR vs. the 10 year government yield in 2013:
All 3 sector ETFs were had hit when the rate move higher accelerated in mid-May, culminating in a short-term bottom in late June when the 10 year yield broke out to multi-year highs above the 2.50% level. Since then though, the sector performance has diverged substantially. Consumer staples (green) are at new highs, Utilities (orange) are well off their highs but higher than their May lows, but REITs are below their May lows and essentially flat in 2013.
REITs were also most severely impacted by the move higher in rates in the past week. Meanwhile, no major sector has shown a real positive correlation with 10 year yields (though technology and regional banks have been the least negatively correlated).
Friday’s non-farm payrolls report could be another catalyst for a major move in rates. I anticipate the above correlations to continue to hold as long as the Fed tapering speculation remains at the forefront of traders’ thoughts.