The change in bond yields could ruin the celebration at the mansion

Lubrication in the stock bubble? The capital market is boiling, as evidenced by the 15 companies that have completed their initial public offering (IPO) since the beginning of the year, the biomed index, which jumped 41%, the blueprints and oil and gas exploration index, which rose by 20%, and the SME60 index, which climbed 18%.

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However, not everyone takes part in this celebration, and it seems that those who were not invited to it are the ones who have the power to destroy it and bring it to an end. Government bonds have been suffering from a weakness that cannot be ignored since the beginning of the year. The table of bond index returns is closed by government bond indices, which have recorded declines of 5.3% -2.3% since the beginning of the year.

Tel Aviv Stock Exchange Photo: Bloomberg

On the other hand, at the top of the table are the index-linked bond indices, which recorded price increases of 4.1%. These are the two sides of the same cent. In recent months, there has been a gradual but consistent trend of rising yields on US bonds, with the 10-year US government bond, which traded at a low of 0.5% in August 2020, today trading at a yield of 1.34%.

This is against the background of the rise in world commodity prices, especially the oil barrel (Brent type), whose price almost doubled during that period, and even more: the price of an oil barrel jumped by 228% from the corona, from $ 19 a barrel in April 2020 to a current price of more From $ 63 a barrel. Rising commodity prices lead to an increase in inflation expectations that may occur in both food prices and production and transportation costs.

Bypass the exchange rate

In recent years inflation has been nil and has allowed for zero interest rates. However, in the scenario that inflation rises and raises its head, this is likely to cause a reaction in the form of an increase in the interest rate. This phenomenon crosses oceans and hits waves both in our local and small market and accordingly, the yield of shekel government bonds (0330) also rose in that period from 0.6% to a current yield of 1.1%.

At the same time, an interesting phenomenon can be seen in forex-linked bonds, which have recorded a 4% increase in their price since the beginning of the year, while the exchange rate of the dollar rose by only 1.9%. The dollar in the scenario of raising interest rates in the US that will lead to an increase in the attractiveness of the US currency.

Investors in government bonds should not be pitied, just as there is no point in envying forex-linked holders. The former have in recent years enjoyed huge capital gains that would not embarrass investors in the stock market, and the latter suffered last year from the strengthening of the shekel. The point is that the same gains in government bonds achieved thanks to the decline in interest rates and the internalization that is expected to remain low for a long time to come, will become losses in a scenario where expectations regarding US interest rates will change.

In the scenario that the US administration launches the new $ 2 trillion incentive program (12 zeros after the 2!), The move is expected to be funded through a bond issue. Increasing supply naturally puts pressure on the price.

For now, the waves from the US are washing away only government bonds and only wetting the margins of corporate bonds. However, this phenomenon cannot last long. Corporate bond prices are directly affected by government bond prices. Continued rise in bond yields Government bonds will inevitably also lead to an increase in corporate bond yields.

The rise in bond market yields has various effects on the stock market. In the short term, as long as the rise in yields is insignificant, stock prices are almost indifferent. Stocks and bonds are substitute products, and to a certain extent the declines in the price of one actually lead to an increase in the attractiveness of the other.

The bonds as a safe haven

In the medium term, however, as the rise in bond market yields becomes more significant, it also has implications for stock value and there are two reasons for this. First, when interest rates reach a high level, investors prefer to invest in relatively low-risk assets over stocks, hence the end The celebration may be shortened.

Second, the value of the shares is directly affected by the interest rate at which the valuers capitalize the companies’ profits and determine their value, and the higher the interest rate, the capitalization rates increase accordingly, shrinking the value of the companies.