Staying grounded as rates drift higher

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By Russ Koesterich, BlackRock’s Global Chief Investment Strategist

Stocks fall even as yields spike

Stocks fell again last week amid more mixed economic data releases and a sharp increase in bond yields. The Dow Jones Industrial Average dropped 0.89% to 17,849, the S&P 500 Index fell 0.71% to 2,092, while the Nasdaq Composite Index held up better, slipping only 0.04% to 5,068.

Meanwhile, the yield on the 10-year Treasury rose sharply from 2.12% to 2.40% as prices correspondingly fell. Indeed, although last week featured multiple signs that global growth remains sluggish, this did not stop bond yields from hitting fresh highs for the year. While the year-to-date rise in yields has been modest, parts of the market sensitive to rate increases have still proved vulnerable. For investors looking to ride out this change in the rate regime, we’d look at financial and health care stocks..

Gyrations in bond markets

Last week confirmed what many investors already suspected: Global growth is unlikely to accelerate this year. Evidence included a 10% plunge in cyclically sensitive South Korean exports, a markdown of global growth estimates by the Organization for Economic Cooperation and Development, weak US factory orders and a tepid read on the US economy by the Federal Reserve (Fed).

But there were some positives as well, mostly in the United States: a strong manufacturing survey from the Institute for Supply Management, a 280,000 increase in net new jobs in May and a modest acceleration in wage growth.

Despite the mixed messages, bond yields resumed their ascent. In the US, this is partly a function of shifting expectations around the date of the Fed’s interest rate liftoff. Consistent with our view, investors are now seeing September as the likely date for that first fateful shift in monetary policy. However, the rise in US real yields—now up by more than 50 basis points (0.50%) since mid-April—still seems severe in an environment characterized by uninspiring growth. Part of the explanation lies in the fact that European bond yields, which have experienced a similar surge, are no longer anchoring global yields to the same extent they did a few months back.

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