Understanding Interest Rates Impact

This is the most important chart to watch for asset allocators. Over the last 10 years people loved bonds because of one simple yet amazing property - a negative correlation to stock markets. Investors got so used to the negative bond/stock correlation that they assume it’s always going to be there - but history shows that’s not true. As the chart below from my friend Dan Rasmussen shows by going back almost 200 years: 1) The stock/bond correlation is actually positive (!) if core inflation is above 3% (red area) 2) The magic negative correlation feature only kicks in with core inflation predictably below 3% (green area) The inflationary year of 2022 was a wake-up call for many: bonds and stocks dropped together and the ''unbeatable'' 60/40 portfolio ended up causing a lot of damage. Family offices, pension funds, endowments and investors around the world who built a portfolio on the assumption that ''bonds are always a good diversifier for my stocks and risky assets'' had a very bad time in 2022. So here is why this is a key chart to watch for macro investors. Core inflation has been stuck around 3% for a bit, and given the outsized deficits and tariffs it could be this way for quite some time. Next year investors might need a hedge for their (failing) hedges – long bonds (and long the US Dollar). A truly diversified portfolio shouldn't only rely on bonds as a diversifier: for periods of heightened macro volatility, investors should also be exposed to true diversifiers like commodities, gold, hedge fund strategies like global macro, and other alternatives. Do you think bonds will act again as a perfect portfolio diversifier? Or do you also look at other diversifiers like commodities or hedge funds? 👉 If you enjoyed this post, follow me (Alfonso Peccatiello) to make sure you don't miss my daily dose of macro analysis.

🔴 #Japan 30-year yield breaks 3%, not seen since 2000. Here are the potential consequences for global markets: ▶️ Unwinding of the Yen Carry Trade: Japan’s low interest rates have made the yen a funding currency for carry trades, where investors borrow in yen to invest in higher-yielding assets abroad (e.g., U.S. Treasuries). Rising JGB yields reduce the attractiveness of this strategy, potentially triggering an unwind. ▶️ An unwind could strengthen the yen (already up 8% in 2025) and cause volatility in global markets, particularly in currencies, equities, and U.S. financial assets. A severe unwind could resemble or exceed the market turmoil seen in August 2024. ▶️ Capital Repatriation and Impact on U.S. Markets: Japanese investors hold $1.13 trillion in U.S. bonds. Higher JGB yields could prompt capital repatriation, as investors sell U.S. Treasuries to buy JGBs offering competitive yields. This could push U.S. Treasury yields higher, increasing borrowing costs globally and pressuring equity markets. Analysts warn of a potential “global financial market Armageddon” if repatriation accelerates. ▶️ Global Bond Market spillovers: Rising JGB yields contribute to a global trend of increasing long-term yields, as seen with U.S. 30-year Treasury yields surpassing 5%. ▶️ Currency Market Volatility: A stronger yen due to higher yields and capital repatriation could disrupt global trade and investment flows. A rapidly appreciating yen is unsustainable for Japan’s export-driven economy, potentially prompting BOJ intervention to weaken it. Currency volatility could exacerbate global market instability, especially if combined with U.S. policy shifts (e.g., tariffs or dollar weakening).

EndGame Macro: A major shift is underway in global bond markets, and it’s starting in Japan. Japanese life insurers some of the largest institutional investors in the world are now selling Japanese government bonds (JGBs) at the fastest pace on record. Why? Because their duration gap has turned sharply negative for the first time in modern history. The duration gap measures the mismatch between the interest rate sensitivity of assets and liabilities. A positive gap means an insurer’s assets (like long-term bonds) respond more to rate changes than their liabilities (like annuity payments), which is generally manageable. But now, the gap has flipped to −1.48 years, the lowest on record. That means rising interest rates are hammering insurers: their liabilities are becoming more expensive faster than their assets can keep up forcing them to unwind long-duration holdings to stop further P&L damage. You can see this in the chart that from 2016 to 2020, insurers comfortably held a 4–5 year positive duration gap. But that edge eroded as Japan’s long-term yields rose and BOJ Yield Curve Control lost credibility. Now that the 30-year JGB yield has breached 2.75%, these insurers are facing mark-to-market losses and they’re being forced to sell into weakness. The second chart shows the result that net JGB flows from Japanese life insurers have plunged into deep negative territory through early 2025. This is not a tactical rotation it’s a systemic duration de-risking event, and it’s happening in the world’s most tightly held sovereign bond market. Why this matters globally: •Japanese lifers are major holders of U.S. Treasuries, European sovereigns, and global credit. If they’re de-risking at home, they may need to sell foreign assets too, creating ripple effects across global bond markets. •A withdrawal of Japanese capital means fewer buyers for long-duration debt at a time when the U.S. and Europe are issuing record amounts of it. •It signals the limits of central bank yield suppression. The BOJ may be forced to step back in with stealth QE or risk a bond market crisis. •It also injects volatility into FX markets particularly USD/JPY as capital flows repatriate or hedge mismatches widen. Bottom line: This isn’t just about Japan. It’s the leading edge of global duration stress. The BOJ’s failure to maintain policy control is forcing private capital to do what central banks fear most exit long duration at scale. The Japanese lifers are the canary. If this continues, other markets will follow. Watch the yield curve, watch FX hedging costs, and most of all watch what they sell next.

Why are spreads on new M&A transactions in the private credit and syndicated finance markets converging in 2024? Traditionally, spreads on private credit loans have featured a premium of 100-200 bps, at a minimum, compared to those on syndicated loans. > Private credit loan borrowers agree to pay this premium in exchange for features such as certainty of close at an agreed-upon spread, or not having to obtain ratings. > With M&A and buyout activity relatively scarce, due to still-high base rates, and with investor appetite for risk increasing, loan supply is running behind investor demand by a record amount. As a result, credit spreads are compressing. > In 2023, PE-backed borrowers rated B-minus saw spreads ranging from 350-to-525 bps over SOFR on syndicated loans supporting buyouts and other types of M&A deals. > For private credit, that range was much higher, 525-to-775 bps. Looking at the data another way, the difference between the midpoint of these ranges was 212.5 bps. > So far in 2024, syndicated loan spreads have stayed within a tighter range of 400-to-500 bps vs. 475-to-625 bps for private credit transactions. >> The gap between the midpoint of these ranges has narrowed to 100 bps. >> Private credit lenders are displaying a willingness to forgo some or all of that spread premium. Failing to do this could well have severe consequences, particularly when activity in lucrative deals, such as buyouts and M&A, is lacking. > The market already has seen a notable shift in momentum from private credit in 2023’s second half to the syndicated loan segment in 2024. > More than $13Bn of loans provided by private credit have been refinanced with a syndicated loan so far in 2024. Another indication of increased risk appetite from investors: > In 1Q24, the syndicated loan segment has reopened in a big way for lower-rated issuers to reprice those deals that had originated before credit spreads narrowed. > In the current market, private credit lenders are receiving calls from PE sponsors with requests to slash pricing by 100 bps, with few administrative obstacles. > That means one advantage that private credit lenders have long touted — that a sole lender or small lender group is easier to work with — can be seen as a double-edged sword, as it’s relatively simple for a loan issuer or sponsor to request a price cut to a single issuer or small club. Take this in: In 1Q24, borrowers were able to move from the private credit into the syndicated loans for cost savings of more than 300 bps on second-lien loans. > Private credit lenders are responding in a different way to market pressures — by offering loans at spreads in line with what’s on offer in the syndicated loan market. > And looking to the near-term, the repricing wave that occurred in 1Q24 appears to be continuing. 'Reprice or else lose market share to a syndicated loan’ trend sweeps private credit. Krishank Parekh | LinkedIn | LinkedIn Guide to Creating

Still Golden Default rates for High Yield Bonds, Broadly Syndicated Loans in U.S. & Europe have likely peaked. As the Federal Reserve & ECB embark upon its path to lower interest rates, debt service relief is around the corner. I believe we have seen the cycle high for defaults and in the coming months default rates will begin to trend lower. Corporate earnings have proven resilient and speaking for most companies who have survived or thrived through the most challenging rate environment in recent memory, the skies look clearer. What is true for Public Credit will also prove true for Private Credit as Direct Lending will experience a similar trend. In this cycle, High Yield Bonds have faired much better vs. Broadly Syndicated Loans when calculating default rates. In contrast, price performance of BSL outperformed its fixed coupon counterpart in thanks to shorter duration plus ~200bp coupon advantage for BSL v. HY bonds (given the shape of the yield curve/SOFR). Recovery rates are also inching higher as well. Telecom, Pharma, Media, Packaging, Business Services, Software represent sectors where overleveraged companies have had to address their heavy debt loads. Capital Solutions have been a blessing for many equity holders in these industry sectors, especially for issuers who negotiated flexible documents and weak covenants, a condition that has benefited the equity at the expense of certain creditors who become structurally subordinated, allowing new money creditors to step to the front of the line. Despite a positive outlook for HY credit, there is still ample opportunity for opportunistic investors. I expect LBO transactions to pick up as rates decline and the new issue calendar to become robust in the coming months. Marathon Asset Management is seeing robust deal flow across our private credit origination platform and it’s my expectation that Direct Lending will continue to post impressive results in 2025, just as it did in 2023 and 2024. With the credit cycle turning more positive, the Golden Era of Credit is alive and well. I have three suggestions: Allocate, Allocate, Allocate.

Treasury yields are never just one number—they’re three stories at once. Using August 2025 as example, the 10-year Treasury at 4.23% breaks down into: A • 2.38% expected inflation • 0.97% expected real short rate (R*) • 0.88% bond risk premium That’s the real anatomy. Two-thirds of the yield is about inflation credibility. The rest is growth equilibrium and investor sentiment toward long bonds. History matters. From the 1980s to 2020, all three components fell—driving the great bond bull market. Post-2021, it flipped. Inflation expectations stayed anchored, but real rates and premia moved back into positive territory. That’s why bonds finally pay a real yield again, but their diversification role is weaker. Here’s the friction. Investors who still think of Treasuries as “return-free risk” are behind the curve. With ex-ante real yields near 2% and premia close to 1%, bonds contribute to returns again. But if inflation expectations de-anchor, the hit is double—yields climb, correlations flip positive, and the hedge role disappears. Global data shows the same pattern: higher real yields and premia driving the shift everywhere from Germany to Canada, with Japan as a partial outlier. Diversification isn’t dead—it’s just not as simple as “own bonds and you’re safe.” Portfolio takeaway: • Treasuries are investable again—don’t ignore them. • But they’re not a perfect hedge—pair them with other diversifiers like gold, trend, or alts. • Think global, not just U.S.—the repricing is worldwide. Would you treat bonds as a return engine or a hedge in this cycle? If inflation expectations break higher, how does your allocation shift? Do you diversify bond exposure globally—or concentrate in the U.S.? What’s your alternative hedge if Treasuries fail? For more see our Nomura CIO Corner: https://lnkd.in/e4TCax_g #Treasuries #BondMarkets #Yields #Inflation #Diversification #Nomura #CIO #Macro #Markets

Same loan amount, same tenure, same credit score, but why are you paying higher interest than your friend? The RBI reduced the repo rate by 100 basis points in 2025, from 6.5% to 5.5%. Yet millions of home loan borrowers haven't seen their EMIs drop! Here's what's happening: In India, home loans follow different rate systems. → MCLR (Marginal Cost of Funds based Lending Rate) If your loan is on MCLR, your bank decides when to reduce your rate. They're not obligated to pass on the repo cut immediately or fully. → EBLR (External Benchmark Lending Rate) If your loan is on EBLR, your rate is directly linked to the repo. It resets automatically every 3 months. When the RBI cuts rates, you benefit within 90 days. The RBI mandated EBLR in 2019 for faster rate cuts - but only new loans got it automatically. Today, over 40% of existing home loans in India are still on MCLR or older systems like Base Rate! And, this isn't a small difference. Take a ₹50L loan over 20 years. → If you're on MCLR at 8.5%, your monthly EMI is ~₹43,391. → If you're on EBLR at 7.5% (post rate cut), your EMI drops to ₹40,280. That's ₹3,111 saved every month. Over 20 years, that's ₹7.46L in total savings! It would cost you anywhere between ₹25K - ₹30K to switch from MCLR to EBLR as a one-time fee. But the math works heavily in your favor. A small one-time cost could save you lakhs in interest. Send this to someone who needs this!

Long-duration US Treasury bonds have plummeted by a jaw-dropping 46% since March 2020, marking one of the most significant financial events in recent history. 🤔 𝐖𝐡𝐲 𝐃𝐢𝐝 𝐈𝐭 𝐇𝐚𝐩𝐩𝐞𝐧? The Federal Reserve's aggressive rate hikes, aimed at curbing inflation, have been the primary catalyst. As bond prices and yields move inversely, the surge in yields led to a sharp decline in bond prices. The 10-year Treasury note's yield alone skyrocketed from <0.7% in March 2020 to >3.5%. 🌐 𝐈𝐦𝐩𝐥𝐢𝐜𝐚𝐭𝐢𝐨𝐧𝐬 𝐟𝐨𝐫 𝐆𝐥𝐨𝐛𝐚𝐥 𝐌𝐚𝐫𝐤𝐞𝐭𝐬, 𝐈𝐧𝐜𝐥𝐮𝐝𝐢𝐧𝐠 𝐈𝐧𝐝𝐢𝐚: Global Ripple Effect: The U.S. bond market's tremors can send shockwaves across global financial landscapes, potentially affecting asset valuations and investor sentiment worldwide. Indian Markets at Crossroads: Indian investors with diversified portfolios, including U.S. assets, might feel the heat. Moreover, global economic shifts can influence foreign investments, trade dynamics, and currency movements in India. 🔮 𝐎𝐮𝐭𝐥𝐨𝐨𝐤: While the immediate aftermath is turbulent, it's essential to see the bigger picture. Bonds, traditionally the 'safe havens', might undergo a perception shift. Investors globally, including in India, will need to: ✅ Re-evaluate their portfolios, considering the changing dynamics. ✅ Diversify investments to include Equities and Commodities mitigate risks. ✅ Stay informed and be prepared for potential market volatilities. The financial landscape is evolving, and so should our strategies. 📈 #GlobalFinance #IndianMarkets #BondCrash #FinancialOutlook

Understanding Capital Depletion in a Rising Interest Rate Environment: Focus on Backbook Management Recent increases in interest rates underscores the importance of understanding the impact of rate changes on a bank's capital position. Diminishing economic value invariably leads to a depletion in capital. In this context, the assumptions made for the backbook portfolio are of high concern. 1. Capital Spreading Assumption: When capital serves as an offset to fixed mortgages rather than a hedge, the scenario becomes increasingly problematic with the rise of interest rates. In a simplified example, consider a bank using capital to offset the risk of its fixed mortgage portfolio. As interest rates increase, the value of these fixed mortgages decreases, because they have been previously locked in at a lower interest rate vs the current market rate. However, unlike a swap where the value would rise to mitigate the diminishing mortgage value, the capital used in this manner does not increase in value. The absence of a counterbalancing increase causes the capital to deplete. 2. Current Account Assumptions: Banks often make assumptions about the behaviour of current accounts to hedge fixed assets. One common but imprudent assumption is that the current accounts will perpetually incur zero percent interest, and that customers would remain with the bank, irrespective of interest rate fluctuations. However, if rates are not passed on to the customers, there is a substantial risk of losing them. This leads to liquidity issues and, by extension, erodes the capital base as new funding must be acquired at a higher interest rate. As there is no offsetting swap for mortgages hedged using a current account assumption, this decrease in value for mortgages depletes capital. 3. Prepayment Assumptions: Relying on historical data for behavioural modelling is advantageous, but only under stable economic conditions. For instance, if a bank uses 2021 data to forecast prepayment rates for 5-year mortgages, it may find itself misaligned with current realities. With higher interest rates and a less buoyant housing market, the expected prepayment rates can deviate significantly from actual rates, with actuals being much lower than forecast. This misalignment is problematic as it makes the asset positions appear smaller than they turn out to be. As a result, the capital base depletes more and more over time, as the bank is forced to hedge at the current higher market rate, or fund at the higher funding rate (this is akin to acquiring "new" mortgages at c1%-2% in the current market, but they always there, hidden by the assumption. These asset positions begin to slowly appear on the gap every month as prepayments fail to materialise). These scenarios evidence the need to constantly reevaluate backbook assumptions. By fostering a more accurate and realistic approach to these crucial elements, banks can position themselves advantageously in this unpredictable landscape.

It’s been a difficult end to the quarter for investors, with long bond yields rising sharply and global stocks falling around -4%. 📉 In fact, the US ‘equal weighted’ stock index and small caps are verging on negative territory for the year. And it feels like we have reached an important point for market psychology and trends. The new news, of course, is rising bond yields - US 10y Treasury yields are up some 40bp in the last 2 weeks (and around 80bp since the start of the summer). That’s connected to a ‘higher for longer’ interest rate narrative in markets, and some technical forces which have re-steepened the still-inverted yield curve. ❓There’s an important discussion to be had about ‘higher for longer’ interest rates, and what that precisely means. But leaving that to the side for now, sharply rising bond yields have two important effects on the #stockmarket : 1️⃣ Rising discount rates and bond volatility impact stock valuations. The equity risk premium is now around 2.5% in the US. That’s not at doctom extremes, but it is a way below normal. You can see in chart 2 (below) how the earnings yield has decoupled from the real bond yield (the TIP). This tells us that the stock market needs continuous good news to keep the show on the road. If the news flow is a bit mixed - or outright disappointing - then pricing needs to adjust. 2️⃣ Tighter financial conditions slow the economic cycle. For consumers, tighter credit conditions, alongside exhausted excess savings and a softening labour market, mean a tougher outlook now. Recent sharply rising bond yields intensify this story for households and other parts of the economy. Higher oil prices don’t help either. So growth is at risk as we head into 2024, but stock analysts still expect >12% profits growth in the US next year. It seems very ambitious, and expectations may need to reset lower. 🔚 For investors, these last two weeks have meant a difficult end to the quarter. Global stocks and bonds are down for Q3 overall. And, amid key leading indicators pointing to recession, the market scenario is set to remain choppy for the time being. #economy #investing Chart sources = HSBC AM, Macrobond