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American Rates Are Rising, The World Is Shaking

The US government bond currently yields more than 3X the dividend of US equity markets, making it an interesting alternative to stocks.

By EC Invest

Interest rates on US debt are soaring, the 10-year rate approaching 4.7%, a level it had not seen since last spring. This rebound is unfortunate as it takes the opposite of investors, who expect a downward trend in credit prices in the US and elsewhere. Gradually, markets will get used to this new reality. But not without some turbulence.

The Fed’s plan threatened

Having wagered many US key rate cuts in 2024, investors had to settle for a minimum service and a benchmark key rate between 4.25% and 4.5%. They have, therefore, pushed their bearish expectations back to 2025. This scenario was supported by the Fed only a few months ago. Still, it is increasingly threatened by resuming inflation and customs duties wanted by Donald Trump that could further strengthen it. The Fed is now cautious and may only lower its key rates once in 2025.

Therefore, the price of money in the US will remain high for a longer period, disappointing investors who were expecting a cheaper loan that would revive activity.

An impact on all debt markets

If US debt yields are being tracked everywhere, it is because they are the ultimate risk-free asset. Investors who do not want to take risks can expect this return, which constitutes a reference for the world of finance. In principle, only higher levels of performance can justify going elsewhere.

The rise in US rates puts upward pressure on the yields that the rest of the world has to offer to finance itself. So bond yields remain high or are rising everywhere, despite efforts by central banks, most of which are in a bearish rate cycle.

Countries with a difficult financial situation are among the most penalised. In the UK, 30-year debt is traded at around 5.4%, a level not seen since 1998. The interest rate differential between France and Germany is at its highest since the euro area sovereign debt crisis. In emerging markets, the downward trend of interest rates has been halted or reversed in countries such as Brazil and Mexico, and credit remains at very high price levels, which penalise economic activity.

…and those of the exchange

The exchange markets are also strongly impacted by the US interest rate differential vis-à-vis other markets. When the returns offered on other lands are considered insufficient, investors rush towards the exit, weakening the passage of the currencies in question. This is the phenomenon we are currently witnessing, with a gain of the US dollar against the generality of other currencies. With yields offered in Europe well below those of the US, the euro is very weak, around $1.03. But he is far from alone. The Japanese yen is not far from its historical lows. The UK pound has been at its lowest for more than a year, the Canadian dollar has been at its lowest since the pandemic, and the Chinese yuan has been moving towards its lowest level since the 2008/2009 financial crisis.

These are significant exchange rate levels, which occur at a particularly delicate time when Donald Trump says he does not want a strong dollar but at the same time threatens the BRICS that would like to create an alternative payment system to do without it. At the same time, the others are preparing for a new round of competitive devaluation of their respective currencies to preserve their competitiveness in markets that are becoming increasingly competitive and limit the impact of the tariffs that the United States is about to impose on its exports.

These factors suggest highly instrumentalised exchange markets, with currencies evolving not as a function of macroeconomic variables but as a policy tool. Under these conditions, it is challenging to expect currencies to become " normal ", moving towards their equilibrium value over time.

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Equity markets are holding their breath

Equity markets are not left out. In the long period of bond yields we have seen since the 2008/09 economic and financial crisis, dividends from equities have often outperformed returns from US debt. The era of “no alternative to stocks” (no alternative to shares) boosted stock markets for a long time. But that time has passed, and, at the moment, the dividend offered by the S&P 500 of the American stock exchange is around 1.27% while the 10-year rate approaches 4.7%.

High interest rates are a double blow to equity markets. On the one hand, investors will wonder if the risks incurred on shares are worthwhile when they can afford a return more than three times higher in the bond market. On the other hand, when rates on government debt rise, the whole credit price is oriented upwards. However, a higher credit cost affects companies' ability to finance innovation and profitability.

This weakens the stock markets. For investors to justify their bet at this stage, they will need to benefit from a favourable economic environment and be able to keep their profit margins on a favourable trend. It is not impossible, especially as future technologies drive markets and the US job market remains tight. But in such a context, the risks are clearly on the rise, and any sign of a void will likely be penalised.

For the world of finance, the rise in US bond rates could mark 2025. Unexpected, it forces investors to rethink a scenario marked by cheaper credit, which has long been driving the markets.

At the same time, at current levels of returns, bonds are a viable alternative to equity markets even if they remain in a good dynamic and, driven by sectors with a future, have not said their last word.

Consider diversifying your portfolio, and don’t neglect the bondholder’s share.

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