Being a financial guru has its advantages. Your writings are read, your speeches are listened to and your tweets seem capable of turning the market on its head. Take Bill Ackman, famous investor turned billionaire, head of the Pershing Square investment fund. At the beginning of August 2023, he revealed a short position in 10-year US bonds. The inverse relationship between bond price and interest rate means that a fall in bond price translates into a rise in yield.

At that time, the US 10-year was around 4%. By the end of October 2023, it had climbed to 5%, while investors were in the higher-for-longer narrative (the idea that the Fed was going to keep rates high for a long time). That's when Bill Ackman posted a message on Twitter: "we covered our bond short". Translation: no more betting on rising rates, we're taking our profits. And we now know that the peak of the US 10-year...was made that same day, at just over 5%. For Bill Ackman, it was a winning bet worth an estimated $200 million. A good day's work.

Is Bill Ackman that influential on the markets, or has he simply sold at a psychological threshold for investors? When we talk about US interest rates and their impact on equities, the 5% level is always mentioned. It's a psychological level for the market and the pain threshold for equities. Indeed, it was in this sequence between August and October 2023 that equities experienced their biggest decline since the start of the bull market in October 2022, with a 9.85% fall.

At this point, it's worth recalling why the level of interest rates is important for equities. Stocks are valued as the sum of discounted future earnings. And we discount with the risk-free interest rate; the US 10-year being the benchmark. So the higher the rate, the lower the value of equities.

In practice, financial markets are a kind of permanent beauty contest. And investor flows go where the risk/return trade-off seems most attractive. At the same time, investors diversify their asset classes, because they don't want to bet everything on the red. As equities and bonds are the two main asset classes, there is always some reallocation from one to the other.

5% is the level at which everyone buys US Treasuries, known in the jargon as the "screaming buy". The reasoning is always the same. There's a topic on US debt. But at 5%, the risk is too well rewarded not to go for it. Especially since a US default is a bit like the risk of the end of the world. It's highly unlikely, and if it happens, bond losses won't be much of an issue.

Can the ceiling become a floor?

At the moment, the 5% level seems to be a ceiling that attracts investor flows. But how long will it last? On a fundamental level, the normal level of long rates is the sum of three elements: potential growth, inflation expectations and the term premium. And the sum of all three points to a floor of 5%.

Let's start with growth. The US economy now seems to be cruising at a higher pace than in the past. While the Fed still estimates potential growth at 1.8%, the Fed itself is projecting growth of over 2% until 2027, after 2 years at 2.5%. Higher growth automatically means higher inflation. Core inflation (excluding volatile items, i.e. food and energy) is struggling to fall below 3%, despite the end of most of the supply constraints caused by the Covid pandemic and then the energy crisis.

Finally, there's the term premium. This is the additional remuneration demanded by an investor to agree to hold a long-term bond and therefore lock in his money for 10 years, rather than rolling over his position, i.e. reinvesting each time on short maturities. In a way, this is the premium for uncertainty about the future. This is currently at its highest level since 2011.

It has to be said that, in terms of uncertainty, investors are well served. They don't really know where the Trump administration's fiscal policy is headed. In this context, the Fed itself doesn't really know where it's going, which should lead it to take a gradual approach to key rate changes, or even to stop there and wait until it's clearer about policy directions. Everything points to higher long-term rates...except Donald Trump, who, as a real estate developer, loves low rates.