Is It Fair to Blame the Bond Market for Equity Market Rout?
Bond markets remained on the sidelines
Since the onset of the current euphoric rise in stock prices after the US elections, the bond markets have remained somewhat muted. Until recently, the ten-year bond yields have been hovering near the 2.5% mark, around 20 basis points higher than the 2016 average of 2.3%. Bond markets haven’t reacted aggressively to tax reforms despite the possibility of higher economic activity after the tax cut. Long-term bond yields, which are tracked by ETFs such as the SPDR Long-Term Treasury Portfolio ETF (SPTL) and the iShares 20+ Year Treasury Bond (TLT), have declined despite the rate hikes and resulted in the flattening of the yield curve.
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Bond markets are only catching up
The situation in the bond market has changed in the previous week with the ten-year Treasury yield (IEF) testing 2.9%, the highest level since 2014. This rise in yields was prevented in the recent past, as investors weren’t convinced that the US Fed would continue increasing rates when the inflation outlook for the US economy remained grim. A series of events that began when the FOMC post-meeting statement signaled a hint of hawkishness from the Fed about rising inflation (TIP) made investors suddenly realize the threat of rising interest rates, which resulted in the increase of bond (BND) yields across the curve.
It is not fair to blame rising yields
The realization of rising rates can be traced to the bond markets, but these markets are not to blame. The bond yields are catching up to reality, and so were the equity market investors, who have enjoyed the wave of optimism since US elections. The US tax reforms have increased the possibility of higher wages, as reported in the February 2 jobs report, which could lead to higher inflation. As a result, the Fed could eventually have to step in to reign in the overheating economy by increasing interest rates. In the final part of this series, we’ll discuss if investors really need to worry about the fall in equity markets.