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Are higher bond yields a concern for the markets?

22 Mar 2021 03:46 PM

Bond yields are the expected profits that came from a fixed income investment in a particular bond during a certain period, expressed as a percentage, and bond yields have a negative relationship with prices - lower prices mean higher returns and vice versa.

US bond yields continued to rise over the past week, reaching their highest level in more than a year, and this came in the wake of the US Federal Reserve keeping interest rates close to zero which prompted investors to bet on economic growth and high inflation.

10-year bond yields rose to 1.75%, the highest since early 2020, while 30-year bond yields reached 2.4%, the highest since July 2019.

Although yields are still low, the recent rise must be taken into consideration as the reasons for these rises are due to the developments in the distribution of coronavirus vaccines, in addition to the financial stimulus pumped by governments and central banks around the world. This prompted investors to raise their expectations that the economy will return to normal levels.

This also encouraged an improvement in the risk appetite of investors to buy high-risk assets such as stocks instead of bonds, and inflation expectations increased considering the cheap money that has been dumped in the markets during the past months, leading to lower bond prices and higher yields - weak demand for bonds was a catalyst for higher yields.

We may see a further increase in bond yields during the current year, but the Federal Reserve may intervene to limit the rise in yields that could be a threat to economic recovery, and that may happen if yields exceed 2% without a major economic improvement.

The impact of higher bond yields was evident on the US dollar, which rose from its lowest level in three years. On the other hand, gold prices fell after reaching record levels during the past year. As for stocks, the situation was mixed, as higher bond yields slowed down the rise of technology stocks and growth stocks, but shares of financial sectors and other sectors that had collapsed due to the spread of the coronavirus pandemic rose.

What may worry investors is the fear of rising inflation, which may push the Federal Reserve to change its monetary policy sooner than expected, either by reducing bond purchases or raising interest rates, and this will have a negative effect on stocks.

However, is inflation really a concern for investors? According to Chairman of the Federal Reserve Jerome Powell, any rise in inflation will be temporary, but looking at the consumer inflation index, we will find that it is not strong enough, so the current rise in yields is not considered negative for stocks, and that the rise in commodity prices such as oil, which is close to its highest levels in 2018, can be accommodated, and that these increases may only be temporary.

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