Global Trend: Bond Yields...Rising?

US stocks appear on track to follow the lead from overnight market action in Europe and Asia, where stocks sold off in response to the rising government bond yields in the US and Germany.

An unusual phenomenon is showing up in global bond markets – bond yields are starting to go up. This isn’t something that started today – it has been taking place for a number of days now – but it has now become a big enough factor that it is becoming a material factor for stocks. It is still too early tell how far the trend will go, since global central banks, particularly the European Central Bank, are active players in the bond markets now. But the trend is nevertheless a welcome change in the interest rate backdrop, which refused to budge despite clear signs of improvement in the underlying economic growth outlook.

Yields for 10-year German bunds are now close to 0.72% after staying close to the 0% level for quite some time. US Treasury yields hadn’t fallen to the same extent as their German peers, but they were nevertheless quite low. Treasures have joined the sell-off as well, pushing yields on the benchmark 10-year instrument to 2.3%.

So why is it happening, and why does it matter for stocks? It isn’t easy to pinpoint one reason for this global trend, but the US Fed is most likely part of the top-most explanation. The Fed is alone among global central banks in that it is getting ready to start tightening policy sometime later this year, while its peers in Europe, Japan and even China are still in easing mode.

Friday’s positive jobs report eased concerns about the US economic outlook after a persistent run of soft economic readings in the first quarter of the year. The outlook for Europe, particularly Germany, has also been improving lately, with business and consumer confidence steadily going up and earlier fears of deflation going into the background. Technical factors like increased issuance of German bonds in recent days are also reportedly in play here, but the economic factors are likely the bigger drivers.

Despite the recent rise, yields are still quite low by historical standards. But anytime you have a major shift in interest rate expectations over a short period of time, it has implications for stocks. As we have been seeing in recent years with stocks benefiting from lower interest rates, the inverse holds true as well. After all, the discount rates at which future cash flows get discounted to the present in any stock valuation framework are a function of interest rates. Higher bond yields make stocks that much less attractive.

Hard to tell how enduring this trend will prove to be, but it’s good to see government bonds across the world start to respond to favorable economic data is this conventional manner.

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Conference Board’s Ken Goldstein: Perfect Storm Needed to Derail US Economy

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