Real rates are firmly positive. This may affect capital allocation

The US10 year treasury hit 3.01% yesterday and is currently yielding 3%. However, besides paying attention to this psychological level, the rate the yield has appreciated over the last eight weeks is noteworthy. This rapidness means the cost of borrowing has jumped markedly, giving very little time for gradual adjustment.

Moreover, real rates are now firmly positive since the beginning of the pandemic period. The positive rates, in turn, impact the rate of return across the risk spectrum. I.e. when real rates were negative, market participants reallocated capital to areas with a positive return, despite the heightened risk. However, this may no longer be the case because investors have less incentive to assume risk. Moreover, this exacerbates as the Fed looks to catch up to the market aggressively. Tomorrow a 50bps hike is priced, and the central bank will announce its plans to normalise its balance sheet.

The required rate of return for risky assets is adjusting and appreciating upwards. This shaping is likely to put pressure on the value of these assets. Moreover, it will continue until a point that looks attractive once again to investors. This rebalancing makes the current outlook uncertain, which translates into higher risk.

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Russell Shor

Senior Market Specialist

Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.

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