Although a shift to higher interest rates is noteworthy, historically, rising rates coupled with rising inflation may actually suggest better performance for some risk assets, per Morgan Stanley.
See – S&P 500 Index: Rising rates indicates a serious shift in market outlook – Morgan Stanley
Key quotes
“There have been multiple episodes – during 1997-1999, 2004-2006 and 2016-2018 – when real yields went up and so did equities. Historical equity and credit performance have been better when rates are rising than when rates were falling, especially when rates are rising along with inflation expectations, as they are doing right now.”
“In multiple recent episodes of higher rates when risk assets fell sharply, they were all in the context of actual or feared policy tightening and/or they were late in the economic cycle. In contrast, we are clearly in the early part of the economic cycle.”
“The credit market performance in the face of higher rates, particularly higher real rates, is interesting. Excess returns tend to underperform in investment-grade credit with higher real rates while outperforming in high yield credit. That syncs up very well with the views of our credit strategists, who remain comfortable with a down in quality view, with high yield credit benefiting from low duration exposure and higher spread cushions.”
“Higher real yields with declining inflation expectations would be associated with weaker performance of risk assets, as would spikes in real yields driven by fears about the removal of Fed accommodation. To be clear, nothing in our expectations of economic recovery or the Fed policy suggest any such outcomes. Therefore, our conviction remains that real yields are set to rise, but only gradually, leaving the reflation trade largely intact.”
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