While stock markets hit new highs, 10-year US government bonds fell by
10%. What does this mean for the future, and will these falls also cloud the stock market?Leave you with hot technology stocks. Leave you with fabricated stories about battered companies like Game-Stop whose stocks are swaying wildly due to colorful (and invented?) Battles between the daring Robin Hood kids and blood-stained Wall Street sharks. Leave you with wildly leaping cryptocurrencies, or manufacturers of exciting batteries and wind turbines.
The real important story that has been going on in recent months on world stock exchanges is in a different place at all. In another market. A much less exciting market, and much more greyish. A market that Robin Hood’s children are unfamiliar with. But let there be no doubt – this is the most important market in the world: Government bond market.
Daily monitoring of the bond market is about as interesting as watching a growing grass. Seemingly, nothing happens there. But when you step back a bit and take a perspective of more than one day – many things happen there. Dramatic things.
The graph attached here shows an important part of the image. In late July, U.S. government bond yields plunged to a historic low. At the time they were trading around a yield of 0.53% only. But since then the picture has changed markedly. Bond yields – which move upside down from the price of bonds – are on the rise. This week they reached an annual high of 1.4%. Such an increase reflects a fall of 10% In the prices of the bonds themselves.
Not at all sure this is the end. Just two years ago, in February 2019, US bonds were traded at a yield of 2.75%. If they continue their journey and get there in the coming months, it will reflect a 22% drop in bond prices compared to their price level last July. Drama, have we already said?
US government bonds are considered a benchmark for the entire global bond market. The deep currents of the US bond market are felt all over the world.Israel of course. They mainly affect long-term bonds. For example, the Israeli government’s bond index for 10 years or more has fallen in the last six months by about8.5% From 648 points to 593 points. The longest shekel bond, the one redeemed in March 2047, fell during this period in10%, From 149 cents to 134.
The falls in the bond market are of course also raising the level of anxiety inStock markets. Indeed, in the past week the U.S. stock market has lost some ground. The Nasdaq index, which a week ago hit a record high of 14,150 Points retreated since about5%. measure S & P500 Lost so far only 2%.
3 questions
The new situation raises three important questions:
1. What are the reasons for the rise in US bond yields?
2. Is the rise in yields a temporary situation or is it expected to continue?
3. How will the rise in bond yields affect stock markets in the near future?
Well, it’s very difficult to predict the future. But perhaps one can learn something about the rise in bond yields from the not-so-distant past.
1. Why did the yields rise?
The market mainly mentions two such reasons. The first is the rise in oil prices that have been traded for more than60 Dollars per barrel, which raises the probability of inflation developing. At the same time, the price of other types of goods began to rise. In the meantime, this is “good” inflation. Controlled inflation that does not exceed 3% per year. Inflation that allows the economy to return to normal functioning, which indicates a return to demand, which makes it possible to moderately raise wages for workers and start the wheels of the economy.
A second reason the commentators point to is the package of incentives that new president Joe Biden is trying to pass in Congress. Even such a package may provide encouragement to the economy and stimulate demand that has been conquered since the corona burst into our lives. On the other hand, financing of such a package will mostly rely on bond raising. The expectation of a large supply of bonds probably also causes a decrease in its price. And yet, even the big incentive package is seen as a positive move in the medium and long term.
2. Temporary or continuous?
It is difficult to know whether the rise in yields will stop or continue. It can be said that there is a fairly broad consensus that yields will not return to fall below 1% any time soon. In a period of economic growth such low yields cannot remain for long.
On the other hand, if the inhalation does return to moving around 2% As in the past, then current yields are still very low. They still reflect negative real interest rates (inflation-adjusted interest rates). In this case, it should be expected that 10-year bond yields will move in the direction of about3% And perhaps more, so that investors in them can enjoy a positive real interest rate.
Therefore, those who want to know where the bonds are headed – would do well to follow mainly data indicating the possibility of inflation in the US: employment data in the US economy, consumer price index data, commodity prices, the dollar exchange rate, and hints from the Federal Reserve.
3. How will the stock market be affected?
Despite the decline in stock markets over the past week, it is not certain that rising bond yields will continue to negatively impact stock prices in the medium and long term. Over many periods in the past, stock markets have been able to generate positive returns even during relatively high or high interest rates.
High interest rates are not necessarily a bad thing. Especially if it comes to curb inflation and keep it under control. Businesses know how to conduct themselves well below average inflation of 2%. A large proportion of them are able to raise prices and maintain or even raise their profits.
There are industries that definitely enjoy a period of rising interest rates. The banks For example, who can again offer to their customers Deposits Interest yielders. Even companies with a cyclical nature love such periods. Oil and energy companies for example earn more when oil prices go up of course.
Retail chains also enjoy an increase in demand, which is sometimes reflected in a moderate increase in prices in their stores. Companies of basic products like food or home appliances are not harmed by this. And of course, all leisure, tourism and luxury goods companies are enjoying a period of growing demand.
Those who may be slightly harmed are Shares from the technology sector. Not so much because of their direct business, but mainly because rising interest rates are helping to suppress financial euphoria and speculative stock trading. A large portion of stock traders do so on high credit cranes. A rise in interest rates increases their trading costs and may suppress some of the speculative impulse in the market, at least in the short term.
However, this is still only a short-term impact. In the longer term what will affect the share price is mainly their relationship to the companies’ business results. And this connection – at least in some of the leading technology stocks, was lost many months ago.
The writer previously served as TheMarker’s Capital Markets Editor. He is currently in the final stages of writing his first book: “Value Overflow – The Lexicon of the Capital Market.” Do not see in writing a recommendation to buy or sell any securities. The author may hold positions in the securities mentioned in the article.