Rising bond yields raise alarm for equity markets

A consistent rise in bond yields in the United States and India has raised concern as it may have a negative impact on other asset classes, especially stock markets and could affect the market rally. Though the stock markets in India have recently witnessed a remarkable rebound since the March 2020 slowdown following the Covid-19 pandemic disruptions, the spike in yields on government securities may have an adverse impact.

Traditionally there is a negative correlation between rising bond yields and equity valuation as a consistent rise in bond yields prompts the investors to withdraw from equity markets. The investors prefer to invest in bonds in such a scenario.

Sharp hike in Bond yields

According to a Business Standard report the 10-year bond yield in the US has gone up by 44 basis points since the end of July and 75 basis points since the beginning of the current calendar year. The 10-year US government bond had a yield of 1.67% on October 22. It is a sharp hike than that of December 2020 when the same bond had a yield of 0.92%, the report added.

In the last three months in India the bond yields have gone up by 16 basis points. The bond yields are up by 47 basis points as of October 22 since the beginning of the year.  The 10-year government bond in India ended with a yield of 6.37% on October 22, the report mentioned. This is a significant 5.9% rise from the bond yields at the end of December 2020.

Covid-19 Pandemic impact on Bond Yields

Amid the peak of the Covid-19 pandemic the bond yields in US fell to a historic low of 0.53% in July 2020, while yields in India fell to 5.8% in the same month.

The Business Standard quoted Dhananjay Sinha, MD and chief strategist, JM Financial Institutional Equity as saying that a dramatic drop in bond yields and plentiful liquidity fueled the post-pandemic surge in equities, pushing valuations to new highs. As bond yields rise in response to higher inflation, this will unwind.

In India, this would mean greater yields and interest rates as well. Bond yields in India have been 530 basis points higher than those in the US over the last ten years.

Rather than increasing corporate profitability, the majority of the gains in Indian equity markets over the last decade came from stock re-ratings or higher valuations.

The re-rating was prompted by a persistent decrease in bond yields in both the US and India, which made it more beneficial for investors to buy stocks rather than bank FDs and bonds, the report added, quoting market experts.

A substantial drop in interest rates in India and around the world with the outbreak of Covid-19 was part of a long-term trend that began after the global financial crisis of 2008. As inflation rises, this pattern is now reversing, and economists expect this to put downward pressure on equity prices.

Due to these changes in global macroeconomic conditions, the market analysts are predicting a 10% drop in the broader markets, according to the news report.