During the past few days, the rising yield of the 10-year US treasury has attracted the attention of the bond and stock investors all over the world. The yield in a very short period of 75 days had crossed the level of 1.75% on 18th March, creating panic among investors in bonds and growth stocks.
It is the most important interest rate in the world as it influences prices virtually in every other corner of financial markets. It is the benchmark for borrowing costs across global financial markets.
The yield, which was hovering around 0.916% in the last week of December 2020, has started climbing since the beginning of the current year. The rise is due to the highest inflation expectations in the past 11 years in anticipation of a robust growth of the US economy, once the country gets out of the COVID-19 pandemic with successful vaccination of the US population, expectedly by June 2021.
Rising Yield Negative for Gold
The rising yield is negative for gold as it raises the non-yielding metal’s opportunity cost. One does not earn any interest by investing in gold as one does by investing in treasuries. So investors prefer investing in treasuries rather than gold as a hedge against inflation. In view of the constant rise in the 10-year US treasury yield, many exchange-traded funds (ETFs) have started liquidating their holdings in gold.
Experts are of the view that gold may lose its appeal as a safe investment against inflation due to challenges posed by the rising yield. If the yield on the 10-year US treasury surpasses the psychological level of 2.00% in the next couple of months, the depreciation in the value of gold by at least 10% from the current levels of around $1,735 per ounce, is not ruled out.
Bond Markets May Be under Pressure
The size of the US treasury market is around $21 trillion. The price of the 10-year US bonds has gone down by around 10% during the past couple of months because of hefty rise in the yield from 0.90% in December to around 1.67% presently in a short period of three months.
The hedge funds, that tend to invest in bonds for a shorter duration in the hope of appreciation in their prices, have started liquidating their holdings in the bonds due to the constant fall in their prices. The sell- off has also spilled over to corporate bonds raising interest costs for corporates.
The US Federal’s patience on the rise in yield has created panic among the bond investors who are most worried about the rising inflation that is eating away their returns.
Experts say that ultra-loose monetary and fiscal policies will be boosting inflation expectations that could force an unwinding of market positions in bonds for which Fed has no good policy response.
The sell-off in bonds may cause further rise in bond yields as the bond price and yield have an inverse relationship and move in opposite directions.
Negative Impact on Stock Markets
The constant rise in the bond yield is creating problems for growth, especially for tech shares such as Apple, Microsoft, Alphabet, Amazon, Tesla, and others that had appreciated abnormally last year.
Of late, these shares have started correcting and may correct more in times to come because of the rising yield. It may be recalled that growth of tech shares had led the stock market rally in the US and other markets, they may lead the fall in stock markets now.
Market participants believe that the US Fed cannot ignore the rising yields for a longer period and it may be forced to raise the interest rates earlier than expected. It may also announce tapering of the stimulus, which may be impacting the stock markets negatively as the recent rally in the global stock markets had been liquidity-driven and tapering by the Fed will result in sucking out liquidity from the financial system.
The experts are of the view that the US stock markets may correct by over 10% from the existing levels, if the yield on the 10-year US treasury spikes to over 2% in a short span of time.
Will Fed Intervene To Cool Down the Rising Yields?
The stance taken by US Fed on rising yield of the 10- year US treasury shows that it is not in a hurry to initiate any measures to cool down the rising yield such as buying bonds in the secondary market as is being done by the Bank of Japan and the European Central Bank (ECB).
The Fed believes that inflation in US may go up temporarily but may cool down in the longer term, so there is nothing to worry about.
The statement made by its chief Jerome Hayden Powell a couple of days ago, that Fed might start pulling back the support it was providing during emergency times by rolling back the monthly stimulus of $120 billion if the economy starts to grow, strongly makes its intention very clear about the likely tapering of stimulus.
Market observers believe that there may be an outburst of quantitative easing earlier than anticipated as the US economy is expected to achieve the highest growth during the next couple of years that it failed to achieve in the past 40 years.
Indian Stock Market May Also Experience Deep Correction
As is well-known, the rally in the Indian stock market during the past 10 months has been purely driven by the liquidity created by foreign institutional investors (FIIs). The FIIs may intensify selling in Indian equities with the rising fear of sucking out the liquidity by Fed from the financial system in the wake of a likely sharp recovery in the US economy.
The resurgence of the second wave of COVID-19 in the country, led by Maharashtra, may also accentuate the pace of their selling of equities in the Indian stock market, causing a drastic fall in the indices.
(Mahesh Natani, is a financial consultant, based in Indore, MP. Views expressed are personal.)