Investors start to worry about 6% Treasury yields as 5% Treasury yields begin to lose their shock value.

For years, the 5% benchmark US 10-year Treasury rate was seen as the threshold at which the global financial markets began to experience turbulence. This threshold is now 'becoming less of a ceiling, and more like an 'approach point.

Investors are now forced to consider an unsettling thought: what if the number 6% should keep them awake at night instead of this month's breaching 5%?

This theory hasn't been tested enough by the latest move above 5%. Mike Bell, BlueBay Asset Management’s head of Market Strategy, says that it was always a psychological indicator and not a tripwire.

Bell explained that people think there is a magic number at which Treasury yields become a problem. "But it's not an absolute number but a relative one," Bell said.

It is important to compare Treasury yields with other investment metrics. This includes the earnings yield of stocks. Bell claims that the relationship is approaching an inflection, which could set up a selloff of stocks.

The past can provide some useful guidance. MSCI's world stock index lost half its value when the 10-year Treasury yield crossed 5%. This was right before the global financial crisis. A similar decline occurred less than a ten-year-old when a 6.8% increase helped burst the dotcom boom.

JP Morgan analysts believe that a "key shift" in global economic structure, where AI, healthcare, and services play a larger role, is one reason why the pain point might be higher than 5%. These firms continue to spend and expand, regardless of how high borrowing costs are.

JP Morgan stated that the traditional interest rate channel "looks materially less bound" and the "breaking-threshold" of the?stock market may be "significantly higher", potentially in the 5,5%-6,0% range, JP Morgan cited the views of major investors during one of their most recent conferences.

REASONABLE REPRICING

A shift from 5% to 6.0% in the $29 trillion Treasury market, which anchors the pricing of virtually all financial assets would be a significant adjustment to the global capital cost.

A Treasury yield of 6% would indicate either higher inflation expectations or growing concerns over US fiscal sustainability. It could also mean that rates will continue to rise for many years.

Austan Goolsbee, a Federal Reserve policymaker, said that he did not know if markets would react differently if 5% yields were extended for a longer period than in the past.

Invesco's global head of asset-allocation research, Paul Jackson, explained that investors are focused on Treasury yields because they represent the risk-free benchmark for the world. At above 5%, investors have the opportunity to lock in their highest returns since 2007.

Jackson's calculations indicate that world stocks begin to fall when the 10-year yield averages 4.72% over 12 months, and then increases.

The tipping point is still a long way off - the average 12-month yield is around 4.34%. But Jackson has already started to reduce his stock holdings and put some of his money in government bonds, hoping to take advantage of the high yields.

He said that if?Treasury Yields continue to rise, there is a danger of the stock market being lower in 12 month's time.

Emerging Questions

When US yields rise, emerging markets that have been on a 'hot streak' in recent years are often the first to be affected.

Dollar-denominated investments become more appealing when Treasury returns are higher. This drains capital from EM economies, and can push hard-up nations into crisis if their dollar-denominated loans spiral out of control.

Last week, data on?investment flow shows that billions of dollars were withdrawn from equity and EM bond funds. The issuance of emerging-market sovereign bonds has also been lighter than usual in this month.

Alison Shimada is the Head of Total Emerging Markets Equity at Allspring Global Investments. She said that while EM was not in a good place, she was still "constructive" because for now, nothing "horribly went wrong".

The biggest psychological risk is the most likely.

When investors start to ask if 6% is achievable, the discussion moves beyond a "temporary" spike in yields. The discussion shifts to the possibility that the 'era of ultra-cheap and abundant liquidity has ended. This will force global asset prices adapt to a permanent higher cost of capital.

Premier Miton CIO Neil Birrell stated that while the stock market is not showing signs of collapse right now, this could be because investors haven't yet plugged in 5% plus yields to their long-term profit forecasting model.

Birrell stated that "the markets appear fine until everyone runs their valuation models again." "The numbers will come out in the end."

(source: Reuters)