When Do Bond Yields Hurt Equities? | The Big Conversation | Refinitiv

TL;DR

Rising yields have historically coincided with major market events, and investors are concerned about tolerance levels to higher yields due to underlying debts. While rising yields can be a natural consequence of strong growth, the combination of higher yields with excesses such as high leverage could push risk assets over the edge.

Transcript

Over the last 35 years, the US 10 year yield, which many consider to be the global benchmark, has been in a clearly defined downtrend. When the yield has touched the top of this trend channel, it has often coincided with or been the catalyst for some of the major market events over this time period. It preceded the 1987 crash, the 1991 recession, t... Read More

Key Insights

• 😮 Rising yields have historically coincided with major market events such as crashes and recessions.
• 💗 The US 10-year yield is still far from the top of its long-term channel, but concerns about tolerance levels to higher yields are growing due to underlying debts.
• ✋ The combination of higher yields with excesses such as high leverage or an early rate tightening cycle could push risk assets over the edge.
• 🤨 Central banks historically raise interest rates during recessions, and the yield curve often flattens and inverts during those periods.
• ☠️ The focus of central banks, such as the Federal Reserve, is currently on supporting the economy during the COVID-19 crisis, making rate hikes unlikely in the near future.
• 😮 Rising yields in isolation may attract foreign investors to other major bond markets, potentially self-correcting the US market.
• 😘 Central banks aim to maintain low volatility in both bond and currency markets, with interventions being relatively rare and typically coordinated.
• 💱 The ability of policy makers to unilaterally impact their currency is limited, and currencies should be allowed to freely float as a balancing mechanism.
• ☠️ Other factors such as interest rates, yield differentials, availability of collateral, and foreign purchases of treasuries play significant roles in currency determinants.

Questions & Answers

Q: How have rising yields historically impacted major market events?

Rising yields have often coincided with significant market events such as the 1987 crash, the 1991 recession, the dot com bust of 2000, the market peak in 2007, and the bear market of Q4 2018. The top of the long-term 10-year yield channel has often signaled potential market disruptions.

Q: What factors could push risk assets over the edge in the current environment of rising yields?

When higher yields are combined with underlying excesses such as high levels of leverage or an early rate tightening cycle, they could create tight economic conditions and destabilize risk assets. The concern today is that tolerance levels to higher yields are lower due to the size of underlying debts.

Q: How have central banks historically responded to rising yields?

In the last 30 years, major recessions have seen the Federal Reserve raising interest rates, which has also led to a flattening and inversion of the yield curve. However, it is unlikely that the Fed will increase interest rates or taper their QE program in 2021, as the focus is on supporting the economy during the pandemic.

Q: Could rising yields destabilize markets?

While rising yields themselves are not sufficient to knock back equity markets or push economies into recession, the combination of higher yields with underlying excesses and economic tightening could lead to market instability. The tolerance level of the market and the Fed to higher yields will determine the potential impact.

Summary & Key Takeaways

• The US 10-year yield has been in a downtrend for the past 35 years and has often coincided with major market events. Investors are concerned about tolerance levels to higher yields given the size of today's underlying debts.

• Rising yields combined with high levels of leverage or an early rate tightening cycle could tighten economic conditions and push risk assets into a bear market.

• Historically, recessions have been accompanied by a flattening and inversion of the yield curve, driven primarily by increases in front-end interest rates.