Why the stock markets cannot ignore the bond market turmoil

Not a full-blown rout, but certainly a steady retreat, albeit an orderly one for the time being. The downward trend that has swept through the bond market in recent months, coupled with the corresponding rise in bond yields, saw a further episode yesterday, as reflected in the data captured by the Bloomberg index tracking global bonds: in this case, rates are at their highest since 2008 and even exceed the levels reached three years ago, when inflation was much higher than it is now and central banks were engaged in an aggressive cycle of rate rises to curb it.

Expectations regarding the actions of the Federal Reserve, the ECB and other central banks are, in fact, now as then, among the underlying reasons for the rise in yields, alongside the resurgence in prices linked primarily to the crisis in the Middle East and the rise in energy commodity prices (Brent crude has risen back above $94 a barrel). Added to these factors this time is the increasingly substantial risk premium that investors are demanding from sovereign issuers due to fiscal uncertainty, which is weighing particularly heavily on longer-term maturities, and, to a lesser extent for the time being, the competition exerted by the enormous volume of paper flooding the bond market to finance investments in artificial intelligence.

However, the situation regarding government bonds is plain for all to see: in the United States, yields on 10-year bonds are at their highest since the start of last year (4.77 per cent) and those on 30-year bonds are at their highest since 2006 (5.25 per cent); the Japanese 10-year bond has hit 3 per cent for the first time since 1996, whilst the Australian 10-year has returned to 2011 levels (5.18 per cent); finally, the UK 30-year bond had not reached 5.86 per cent since 1998. Europe is no exception, with the 10-year German Bund at 3.35 per cent (its highest level in 15 years) and the Italian BTp at 4.18 per cent, once again trailing the French OAT by three basis points, the latter being affected by the country’s political and financial situation.

What seemed to capture attention yesterday was not so much the ‘war report’ presented by bond yields, but rather, for once, its impact on the equity market. The debate is, in fact, becoming more heated regarding the extent to which stock markets can tolerate high bond yields. “Many investors regard a 5 per cent yield on 10-year US Treasuries as an important psychological threshold,” observes Mathieu Racheter, head of strategic equity research at Julius Baer, whilst pointing out that, historically, the markets have been able to absorb gradual increases similar to the current one.

Moreover, the view is gaining ground amongst investment experts that the movement in the bond market appears, all things considered, to be under control; it does not constitute a genuine rate shock and, for that very reason, is not yet a cause for concern. ‘Higher yields are more likely to reinforce a rotation rather than put an end to the stock market rally’ points out Racheter, who is convinced that investors need not necessarily abandon technology stocks or the structural winners in the artificial intelligence sector, but should complement them with other sources of return such as “value stocks, particularly those in the financial and banking sectors”.