When it’s time to worry about rising government bond yields

Thought of the day

by Chief Investment Office 30 Jan 2018

Government bond yields are on the rise worldwide. Of the top 34 sovereign issuers tracked by Bloomberg, yields on 90% of them rose over the past week. The German five-year Bund yield briefly broke zero for the first time since December 2015, and is up 12bps over the last week. The five-year US yield is up 7bps over the week and close to 30bps on the month. A particularly sharp bond move on Monday unnerved stock investors, helping push the S&P 500 0.7% lower, its largest drop since September. Rising yields have the potential to hurt equities more, but only under certain conditions:

  • If the rise in yields is reflecting worrying economic conditions, such as stagflation. This is far from the case at present. The US five-year breakeven, the average rate of inflation expected by the market, stands at 2% – the Federal Reserve's target.
  • If the rise is making life hard for companies or consumers who wish to borrow. So far, this isn’t the case either. Financial conditions are the easiest they've been since the mid-1970s, according to the Chicago Fed National Financial Conditions Index.
  • If higher yields start making equities look unattractive by comparison. Yields will need to rise much further before this is the case. The equity risk premium, a measure of equity attractiveness relative to real bond yields, stands at around 5%, compared with an average of 3.2% since 1960.

While we are watching these metrics, currently we don’t believe bond markets are likely to derail equities. Bond yields are reflecting expectations of a move toward an end to emergency levels of easy money from central banks worldwide and a normalization of inflation.

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