Significant Rise in Yields on the US Bond Market

Dear Ladies and Gentlemen

Concerns about monetary tightening in the wake of rising inflation pushed the interest rate on ten-year U.S. government bonds above 1.5 per cent yesterday.

Rise in Yields

A significant rise in yields on the U.S. bond market led to the highest level in the U.S. government bond market yields since February 2020. The prospect of further rising interest rates in the USA makes investments in U.S. dollars more attractive while at the same time, higher interest rates weigh on equity and precious metals investments.

Risk-Off

Any steep increase in government bond yields usually leads to risk-off behaviour. This is precisely what we saw yesterday.

Why Do Inflation Fears Impact Stock Markets?

Why do inflation fears impact stock markets, and why does the stock market react to rising yields with a nervous movement? The reason why inflation fears weigh on the stock market and impact stock markets mostly negatively lies in the fact that any rise in yields usually leads to a lower discounted value of future profits. However, if inflation rises, the effect may be offset at least to some extent on the corporate level by higher future sales and profits but only if such rising inflation can be passed on to customers, and only as long and up to the point where consumers are willing and able to pay the higher prices.

Strong Balance Sheets

Stock markets react to rising yields in varying degrees because some economic sectors are negatively impacted, while others benefit from rising yields. «Losers» may be found, for example, in the real estate and utility sector and quite in general in stocks of companies operating with a high proportion of debt capital that will become more expensive in the future. Usually, growth stocks are also likely to face headwinds, as we have seen over the last few weeks, depending, of course, on their business model. In the case of growth stocks, a more substantial differentiation between companies with strong balance sheets versus cash-burning companies has already started.

Bye, Bye, Equities?

I do not think that the U.S. government yields will rise and rise and rise. This would be a significant blow to the U.S. economy and most probably lead to a yield curve control by the U.S. Federal Reserve System. Therefore, I do not think that we have to say goodby to equities just yet. However, the shift from growth to value may continue and take some of the steam out of stock markets which may be nothing more than a healthy corrective reaction to recent exuberant increases.

Please feel free to share your ideas and thoughts with me, but please do not forget (instead of hitting the reply button) to send your messages to smk@incrementum.li.

Many thanks, indeed!

Ladies and Gentlemen, I wish you a good start into the day, a wonderful weekend, and above all, good health!

Yours truly,

Stefan M. Kremeth