Bond prices have been falling in recent times, with investors starting to believe that central banks will begin reducing their purchases under their respective quantitative easing programmes – not least the Federal Reserve.
This is because the US and global economies are in much better shapes than a year ago. On top of this, there is an even more pressing issue: inflation.
Price pressures are very strong across the global economy right now because of supply bottlenecks, surging energy prices and other temporary factors. In the US, CPI has reached 5.3%, which is more than double the Fed’s target. Chairman Jerome Powell has strongly indicated that bond purchases will be reduced in the coming months.
Given that bond prices have been falling in recent days and weeks, it looks like investors are front-running the Fed. On Monday, they sold off again, with the 10-year Treasury yield briefly topping 1.5% for the first time since June.
Given that the Fed has become significantly more hawkish since June, there is no reason why yields cannot go even higher from here. Put another way, bond prices are likely to fall even more in the days to come as investors price in reduced bond buying from the Fed.
What do falling bond prices mean for stocks?
But what will this mean for stocks? Well, as long as yields don’t rise too sharply and too quickly, we may not see too much of a reaction in the stock markets as a whole. However, as we found out on Monday, it is important to note that not all sectors will react the same.
Indeed, while rising yields could weigh on growth stocks — with technology being the obvious target for the bears, given the sector’s low dividend yields — banks tend to benefit from higher yields, as do some other sectors sensitive to economic growth. There are also other factors that could impact stock prices. For example, rising oil prices might help energy companies, but not so much stocks in the consumer discretionary sector.
So, the combination of rising yields and oil prices are not very good for some technology heavyweights such as Apple, whose products are considered luxury. Companies such as Apple and Microsoft might suffer after years of outperformance if the bond market rout continues. Investors might fret about their high valuations, leading to some selling pressure as the Fed starts to taper its bond purchases.
Other risks facing equities
Obviously, there are other risk to take into account, including, but not limited to, contagion from Evergrande and weaker economic growth in the months ahead.
There is also the potential for a full blown emerging market currency crisis amid stagflation risks and as the strengthening US dollar decreases their purchasing power even more. The Indian Rupee could be among those to watch, given that India is an oil importer. We have already seen fresh record lows for the Turkish lira against the dollar after the CBRT’s surprise rate cut last week.
