The Impact of Rising US Treasury Bond Yields: Explained
The United States Treasury Bond Yield has been showing a significant rise over the past week or so. On Thursday (March 4), the bond yield (or returns) rose to its highest level since 2015— 1.57%. The Dow Jones Industrial Average fell by more than 1% on the same day, while the S&P 500 nearly erased all of its gains made in 2021. As soon as the yield rates increase, we see markets crashing globally. You may recall that our Nifty fell by over 500 points last Friday (Feb 26) due to the same reason. Let us have a detailed understanding of this phenomenon.
A Breakdown of Events
Bonds are debt instruments that are issued by governments and corporations when they require funds. Bond yield is the fixed return that an investor gets on a bond or any particular government security. Amidst the Covid-19 pandemic, the US Federal Reserve had cut interest rates (on loans) to near-zero levels in March 2020. This meant that people could borrow more money from banks at cheaper rates. They could use this money for basic consumption and other requirements, and thus, kick the economy out of recession.
Once the US Fed cut interest rates, bonds became more attractive as they gave fixed returns. There was more demand for bonds, which led to an increase in bond prices. The higher a bond's price, the lower will be its yield. This is because an investor who is buying a bond will now have to pay more for the same returns. As we know, people had also turned away from the stock market as panic had led to a collective sell-off during March-April.
The Current Scenario
In recent months, the situation has more or less turned for the better. The rate of infections has fallen and people are receiving Covid-19 vaccines. The $1.9 trillion stimulus package in the United States will also provide a well-needed boost for all economic activities. Due to these positive sentiments, investors had moved away from treasury bonds to riskier assets such as stocks (as it provided higher returns). This ultimately led to a fall in treasury bond prices and an exponential rise in bond yields to their recent highs.
Since the beginning of 2021, bond yields have surged from 0.9% levels to 1.57%. Higher yields in the US signal that the Federal Reserve might start to increase the interest rates to contain inflation. When economic growth starts to take off in the US, inflation will surely rise. The rise in interest rates will discourage people from taking loans, and there will be less market liquidity. If this happens, investing in stock markets can become riskier. Due to this fear, global investors started to panic and pulled out money from emerging economies such as India— where the economy is recovering at a relatively slower pace.
Large institutions felt it was time to invest more money into low-risk securities and balance their portfolios. They started to sell off their stocks and infuse more money into US Treasury bonds, which are now providing them with high/safe returns. This is why we have been seeing a huge sell-off in our Indian stock markets when there is a spike in bond yields.
The general mood in the Indian stock market was quite positive after the Union Budget 2021 presentation on February 1. We saw benchmark indices (Nifty and Sensex) hit record highs. However, the rising bond yields have now become a major concern for investors. We can also see bond yields rising in the United Kingdom and India as well. Markets have become highly volatile and unpredictable. The increase in bond yields has also impacted the currency market. The rupee closed at 73.47 against the US Dollar on March 1. This was the biggest single-day fall since March 2020. Gold prices have fallen heavily due to the same reason.
In the US, the Federal Reserve has outrightly stated that the recent rise in bond yields would not affect their existing policies. The Fed said that interest rates would be kept near-zero levels until the economy reaches full employment. This is positive news for stock markets, as lower interest rates for borrowings leads to better liquidity.
Many financial analysts have warned that markets could crash further if bond yields continue to rise. However, the recent GDP numbers show that India has made a strong economic recovery. All major sectors such as manufacturing, services, and real estate are showing rapid growth. These are very positive sentiments that would encourage investors to infuse more money into our stock markets (which is already in a bullish phase). Thus, the correction we are witnessing now will most probably be a short-term phenomenon. Do keep a close watch on both domestic and global developments while entering into trades.