The 'Gravity' of High Treasury Yields... A Process of Separating the Wheat from the Chaff in Asset Markets Begins

US Treasury yields are maintaining high levels, recording their highest points in 24 years. While rising interest rates typically cause asset markets to shrink, a strange phenomenon is occurring recently where certain asset markets, including the Nasdaq, are actually showing strength. The analysis provided by The Man Who Explains the Economy (Kim Kwang-seok TV) contains the impact of rising Treasury yields on the real economy and capital markets, as well as the principle of "separating the wheat from the chaff" that occurs in that process.

The 'Crowding-out Effect' Caused by Rising Treasury Yields and the Shrinkage of the Real Economy

When the government injects massive amounts of finance to stimulate the economy, the volume of Treasury bond issuance increases, which leads to a rise in Treasury yields. Professor Kim Kwang-seok defined the phenomenon occurring in this process as the 'crowding-out effect.' Although the government shows its intention to stimulate the economy by injecting finance, if Treasury issuance increases and interest rates rise, it becomes difficult for private companies to issue corporate bonds at high interest rates. In other words, while the government's financial injection may produce short-term results, it results in suppressing the investment capacity of the private sector.

In particular, US Treasuries are known as the safest assets in the world. The video explains this as a matter of 'trust.' Assuming that Treasuries and corporate bonds offer the same interest, investors naturally want to lend money to safe assets like the US government. This is consistent with the reason why the US dollar is called a safe-haven asset. This is because gold and the dollar—namely, US Treasuries—are cited as the assets that will remain until the end, no matter what kind of crisis the world faces.

This status of US Treasuries causes them to perform the role of 'reference rates' or 'guidance' in the global bond market. When US Treasury yields rise, other countries also face pressure to raise their own interest rates to maintain the attractiveness of their national bonds. Ultimately, higher Treasury yields increase the cost of issuing corporate bonds for private companies, hindering new investment, which creates a vicious cycle leading to insufficient job creation and sluggish income and consumption. This is why a cycle is formed where the economy is suppressed by rising Treasury yields and eventually interest rates fall again.

The Ruthless 'Separating the Wheat from the Chaff' Created by High Interest Rates

During periods of high interest rates, a company's ability to survive is starkly divided. Professor Kim explained this as 'separating the wheat from the chaff.' It is a process where companies that can continue their business by borrowing money despite high interest rates are separated from companies that are forced out of the market because they cannot endure the interest burden. This shows a similar trend to the real estate PF (Project Financing) insolvency issues that appeared during the interest rate hike period in 2022. At that time, construction companies that had taken out large PF loans for massive apartment supplies during the low-interest period faced problems with unsold housing and the inability to repay loans immediately after the interest rate hikes. In this process, restructuring took place where insolvent construction companies and financial institutions were excluded from the market, resulting in an effect where the soundness of the remaining companies increased. Professor Kim emphasized, "The truth is always revealed when interest rates are high."

This polarization also appears clearly in the capital market. When Treasury yields rise, companies are divided into those that can issue corporate bonds and those that cannot. In other words, they stand at a crossroads of deciding whether to continue their business by taking out loans despite high interest rates or to close their businesses. The case of Samsung Electronics demonstrates this clearly. Samsung Electronics' provisional operating profit growth rate for the third quarter reached an enormous figure of 7,800% compared to the same period last year. Companies like this, which prove their survival capability through performance and generate massive profits, can continue their businesses by raising funds despite high interest rates. On the other hand, it is difficult for companies with an operating profit margin of only 5–10% to continue their business while bearing loan interest rates of 6–7%. Ultimately, the background behind the rise of certain indices such as the Nasdaq is that blue-chip companies, which have proven their survival capability based on overwhelming performance even in an environment of high interest rates, are leading the market.

The 'Gravity' Acting on Asset Markets and Future Outlook

Interest rates are like 'gravity' acting on the asset market. When Treasury yields rise, they apply downward pressure on all asset markets, including gold, coins, real estate, and stocks. Considering that the size of the bond market is larger than the stock market worldwide, when the yield of a risk-free asset like US Treasuries rises, the reason for investors to stay in other assets by taking risks disappears. The logic is that if you lend money to the United States, you are guaranteed to earn a profit as long as it does not fail, so there is no need to invest in risky assets. As this gravity becomes stronger, the value of all assets is suppressed.

However, this suppression can be reversed when Treasury yields turn to a downward trend. When interest rates fall, the suppressed liquidity flows back into the market, and an 'Everything Rally' may appear, where the values of all assets rise simultaneously. Professor Kim suggested that the point at which Treasury yields plunge could become the driving force for the rise of the entire asset market.

Source: original video (YouTube)