A 10-year yield above 5.1% (5.2%+ as I update) raises the discount rate on equities and makes it harder to justify high valuations, especially for rate-sensitive growth stocks. Higher yields also support the US dollar, which tends to weigh on the Australian dollar. The RBA’s widely expected hike on Tuesday gives AUD some offset by keeping policy rates higher relative to the US. If UBS is right that October hike odds are overdone, that could reverse quickly: a softer core PCE revision could trigger a sharp rally at the front end of the Treasury curve. The weak five-year auction is worth watching: another poorly received sale would suggest debt supply, not just the Fed outlook, is pushing yields up.
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Bond markets are pricing an October Fed hike, and UBS thinks they are getting ahead of themselves. It expects one move in December, easing inflation and strong earnings to carry equities through a measured tightening cycle.
Summary:
- The 10-year Treasury yield rose above 5.2% for the first time since 2007, jumping circa 15 bps on Wednesday and climbing further on Thursday
- The flash composite PMI rose above 58 in September, the strongest private-sector expansion since mid-2021, and input costs rose at the fastest pace in nearly four years
- A $70 billion five-year note sale cleared at the highest auction yield since 2006
- Futures put October Fed hike odds at around 70%, up from just under 50% a week ago
- UBS expects one hike in December, then a hold, with inflation easing over the next six months
- UBS rates fixed income as attractive and forecasts S&P 500 earnings growth of 25% this year and 14% in 2027
The sell-off in US Treasuries has pushed the 10-year yield above 5.1% for the first time since 2007. UBS argues the investment backdrop remains constructive all the same, saying markets are pricing in more Federal Reserve tightening than is likely to materialise. Yields jumped by circa 15 basis points on Wednesday and extended their climb on Thursday, while the S&P 500 fell a little under 1% in Wednesday’s session.
Three forces drove the move. Oil prices have climbed on renewed Middle East supply fears, economic data has run hot, and demand was weak at a $70 billion five-year note sale, which cleared at its highest yield since 2006. The S&P Global flash composite PMI rose above 58 in September, its fourth straight month of acceleration and the strongest private-sector expansion since July 2021. Input costs rose at the fastest pace in nearly four years as fuel and transport costs climbed.
Traders have responded by leaning into a near-term hike. Fed funds futures now put the odds of an October increase at around 70%, compared with just under 50% a week ago, when the Fed lifted its policy range to 3.75% to 4%.
UBS sees that pricing as too aggressive. Its base case is one more hike, in December, followed by a hold. It notes that the median projection from policymakers points to steady rates through 2027, despite a hawkish tone from some officials. The bank expects inflation to ease steadily over the next six months. It points to two reasons: an expected downward revision of around 0.2 percentage points to core PCE inflation in the Bureau of Economic Analysis’s annual revisions later this month, and favourable base effects in the first half of next year.
On bonds, UBS acknowledges that worries over government debt have helped lift yields this year, but argues that high debt does not automatically mean poor returns. It rates fixed income as attractive, seeing higher starting yields as a source of solid portfolio income. Income-focused investors may prefer shorter maturities to limit duration risk. The bank also sees tactical value in medium to long-dated high-quality bonds, and in medium-tenor credit from stronger investment-grade issuers.
The bank is also upbeat on earnings. It sees the latest PMI as confirmation that the US economy is on solid footing, with AI investment adding a further tailwind. UBS forecasts S&P 500 earnings growth of 25% this year and 14% in 2027, and earnings growth for the MSCI All Country World index of 26% and 14% over the same period. It expects that growth to lift global equities over the next six to 12 months.
UBS continues to recommend positioning for further equity gains. It also suggests capital preservation strategies, broad commodities and alternatives to make portfolios more resilient. Whether that view holds will depend heavily on how the Fed responds to the next round of inflation and activity data.
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This article was written by Eamonn Sheridan at investinglive.com.