Bond bashing leads to a stumble for equities

Equity markets were well and truly bashed on Thursday as bond yields around the world rose sharply. German 10 year bund yields have risen by nearly one half of a percent point in the space of a couple of weeks. When we wrote earlier in the week, post the latest euro area inflation data that anyone buying 10-year German bunds yielding 57bp was guaranteed to lose money, we did not expect it to happen quite so quickly.  We have also been at pains to point out that the equity rallies have been interrupted with bouts of volatility and this pattern was likely to remain. Equity markets have struggled to push on in the recent weeks, creating a greater risk of a selloff.

There has been a lot for analysts to digest in the last 48 hours, and for a change Greece has taken a little bit of a back seat. Late on Wednesday saw the release of the latest Federal Reserve's beige book. This survey is conducted to give anecdotal evidence of the state of the US economy in each of the 12 Federal Reserve districts, and was described by the Wall Street Journal a providing a fairly rosy picture of the US economy.

Yields rose across the globe on Thursday as Mario Draghi, in his press conference stated that he expects increased bond market volatility. We regularly comment on the latest fund flow data in our weekly pieces, fund flows this year continue to report capital coming into bonds.  For this reason one would expect when sentiment changes, volatility will increase sharply as buyers are always reluctant to catch a falling knife.

Rising bond yields will always knock other asset price valuations, as these other assets take part of their valuation from their attractiveness to what is called a risk free asset. In reality it must be the most misused expressions one can think of, as those who have bought bonds in the past week will testify to.

Two year US treasury yields have risen over the past couple of days, but at 67 basis points remain close to their lows. Two year yields are considered the best gauge of interest rate sentiment, and the fact 2 year yields have not risen as sharply as longer dated yields, suggests that sentiment towards the timing of the first rate rise has not changed significantly. The fact that the longer dated bond yields have risen faster than the shorter dated ones should be considered an encouraging sign for the outlook for economic growth. Equity investors have tended to favour bond proxy sectors such as utilities, pharmaceutical and staples. Rising bond yields tends to benefit the more cyclical sectors as it's a sign of economic growth, will fund managers be more tempted into these sectors if yields continue to rise only time will tell?

Posted on June 4, 2015 .