The world moves fast, and we just try to catch up! On similar lines, the markets in the US are not just about equities but bonds too.
Lately, the US treasury bond is rising and has started to go up since the last Federal Reserve meeting to reduce the stimulus, signaling that the economy can sustain on its own.
Deep dive:
Before we get too ahead of ourselves, bond yields and interest rates have an inverse relationship. If you see the yields going up, the investors are selling their bonds. That is the ground reality in the bond market.
On top of this, bonds are inherently safe investments so if the yields on safe assets go up, there’s an arbitrage between safe and risky assets. In other words, an arbitrage between stocks and bonds.
Bonds’ relation with stocks:
Fundamentally, when holding a treasury bond makes you more money than a tech stock whose valuation is already in the heated zone, then the likelihood of moving/rotating from stocks to bonds is high.
Hence, investors sell stocks which cause their prices to go down and that’s exactly why the markets have ended in the red post the fed meeting last week.
What are the ramifications?
In order to know the ramifications, it’s imperative to know what bond yield even means in the first place. Right off the bat, these interest rates depict the long-term nature of an economy plus the borrowing cost of any individual.
On similar lines, the lending costs for banks and other financial institutions have surged which in turn pushes the borrowing costs for an individual upwards. Whereas, the long-term stance on the economy is intact.
Higher payments:
This change comes along with already high home prices. So, the rise in yields may directly hit the robust demand for homes amongst Americans.
Put together, it will result in high monthly payments that hit the incentive of home buyers.
Way forward:
If this change is permanent in nature, it might not bode well for equity (stocks) because investors will shift from riskier investments to safer investments offering high returns.
Is the change transitory or permanent, you tell.