The significant event unfolding under the radar of many stock market investors in recent weeks is the relatively sharp rise in yields Bonds U.S. government bond yields due in 10 years, climbed from 0.5% at the height of the corona crisis and 0.93% at the beginning of 2021, to around 1.35% last weekend. This rise in yields occurs even though US base interest rates remain zero and the US Federal Reserve has announced that this interest rate will remain zero for a long time to come and that it will continue to support the economy, among other things, by buying government bonds, lowering debt yields And to the whole economy.
The relatively sharp rise in yields on 10-year US government bonds, which in practice means a fall in the price of these bonds by about 5% -4% from peak levels in early April 2020, is an outgrowth of optimism in the aforementioned global economic recovery. USA in particular and therefore in essence is positive and forms the basis for long-term optimism.
U.S. investors are in the midst of a countdown, at the end of which an imaginary $ 1.9 trillion stimulus program will be launched, which is expected to go through every pocket of a U.S. citizen and push the local economy forward. On the other hand, the incentive program will be financed in large part by increasing the already large national deficit of the US government, so that the supply of government bonds is expected to grow substantially and create pressure on their price.
Progress of the corona vaccine campaign is also boosting optimism in the financial markets, according to which the US economy is on its way to overcoming the huge bump in the corona and leading to an increase in the risk component of investment portfolios at the expense of the relatively safe component of government bonds.
The side effects of the huge incentives of the US government and the US Federal Reserve is a relatively sharp rise in long-term inflation expectations in the US which stand at about 2.14% for 10 years compared to 0.5% last March.
The rise in US government bond yields also affects firms’ financing costs, ie corporate bond pricing, as current risk margins in the corporate market are low and hence the rise in government bond yields produces direct pressure on corporate bond prices that float at record prices.
The impact of rising US government bond yields does not stop the bond market and seeps directly into the pricing of equities and real estate.
The principle of contagion is simple, since the theoretical economic value of a stock is the capitalization of future profits with a capitalization coefficient, which takes into account the risk-free interest rate. As the risk-free interest rate climbs proportionately then it has a direct impact on this pricing. Another way to compare the attractiveness of investing in the stock market and the attractiveness of investing in government bonds is to compare the dividend yield of the stock index with the yield to maturity of the long-term government bond. Article link https://www.news1.news/news/2021/02/rising-yields-in-the-bond-market-an-event-with-limited-potential.html
The higher the bond yield than the dividend yield of the index, the smaller the attractiveness of the stock market and vice versa.
Let us not be mistaken and think that only tradable assets are vulnerable to rising yields since the rise in interest rates directly affects the prices of real assets in the same way as I described earlier but this is usually done with time lag and lack of transparency. Article link https://www.news1.news/news/2021/02/rising-yields-in-the-bond-market-an-event-with-limited-potential.html
The rise in government debt yields brings with it the rise in mortgage prices and also affects the demand for real estate.
The current rise in yields in the US government bond market may continue for the foreseeable future, but it is likely that the potential rise in yields in the short term is relatively limited, since the US government’s debt at the current yield level is 2% – 1.5% per annum. By many investors in the world as an attractive debt and therefore it is likely that at such yield levels interest in the markets in this debt will increase and the rise in yields will be halted.
In a world of zero interest rates in most developed economies, a 10-year US government debt investment at current yield levels is a good alternative to investing in parallel sovereign debt of countries such as Germany and Japan, where the corresponding debt yield stands at 0.3% and 0.1%. Article link https://www.news1.news/news/2021/02/rising-yields-in-the-bond-market-an-event-with-limited-potential.html
The corresponding debt pricing of the State of Israel also takes into account the yield of the US government bonds and it has crept up recently and crossed the 1% threshold for 10 years from a level of about 0.8% at a low. As US yields creep up, this will have a direct effect on the prices of Israeli government bonds. However, our interest rates are also expected to remain nil for a long time. In an event with relatively limited potential and we are unlikely to face a doubling of the yield to maturity of Israel’s long – term government debt in the near future.
Realization in the US stock market as a result of the continued rise in government debt yields may have a negative effect on the trend in the domestic debt market as well as the trend in the domestic stock market as these markets are closely correlated with developments in the US market. That the U.S. government’s debt yields are creeping up requires caution in all of the above over the average life of the investment portfolio and a sectoral adjustment of the stock portfolio to the scenario of a controlled rise in yields and a certain increase in the inflation environment.
Should there be a panic in the markets as a result of the rise in US yields which will permeate the global markets then I understand this is a relatively short term event and limited in its damages and therefore one should remain calm and take advantage of overreactions in the markets to improve the investment portfolio.
The author is a senior vice president, head of the trading, derivatives and indices department at the Tel Aviv Stock Exchange.
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