The post-June rise in bond yields should not have a negative impact on equity markets, consensus sug...
The post-June rise in bond yields should not have a negative impact on equity markets, consensus suggests.
While there were fears that the unwinding of the flight to quality seen in the recent sell-off of bonds would have a negative impact on the equity market, this likelihood has been reduced by a genuine shift in growth expectations.
Peter Oppenheimer, an analyst at Goldman Sachs, says the bond sell-off was largely triggered by the Federal Reserve's 25 basis point cut in June. Asset allocators have had to decide how much the rise in yields was a result of investors worrying they were sitting on expensive bonds, the outlook for which is being impaired by the Fed's policies, and how much there has been a resurgence in appetite for risk.
'For equity markets, the difference is important,' Oppenheimer says. 'As long as it is moderate, a rise in yields that reflects stronger growth expectations has less chance of reversing the recent equity market rally.
'In reality, the factor behind the rise in yields probably reflects a combination of the two possible explanations. It appears bond yields fell to an unusually low level earlier in the year, perhaps supported by Fed comments and a flight to safety away from equities. However, the rise in bond yields does appear to reflect a shift in growth expectations as well.'
Evidence of improved growth is threefold, Oppenheimer continues, in that breakeven inflation rates have been rising, cyclical sectors have been outperforming and bond yields have increased, which was not the case previously.
Cyclical markets such as Japan have also outperformed with, the country significantly beating Europe and the US in the 18 months following the 1997 Asian crisis.
'Nevertheless, there can still be two negative impacts from a rise in bond yields,' Oppenheimer warns.
'First, together with the rise in the dollar that has accompanied the sell-off in bonds, it has reversed around 75 basis points of the 200 basis points of financial easing since March.
'Of course, this is a circular argument. If the rise in yields and dollar reflected confidence in the economy, the Fed may be less concerned that policy, by implication, had tightened. It can also act as a drag on the fair valuation of equities.'
Nigel Richardson, senior strategist at Axa Investment Managers, is growing increasingly bullish on US equities, believing the Fed's actions, while not entirely supportive of bonds, have helped sustain consumer spending.
'So far, the policy of easing has proved effective,' he says. 'Even in the face of falling confidence and a rising saving ratio, consumer demand has continued to expand. Although consumer spending growth is lower than at the peak of the bubble, it has still been running at a healthy pace of around 3%-4%.
'Moreover, when monetary policy was eased during the course of 2001, retail sales were quick to respond, having weakened during the course of 2000. The judgement to date is that prompt policy action is working in the US, which supports our central view US growth will return to trend in the months ahead and help support a continued global recovery.'
Belief economic growth is recovering.
Cyclical markets outperforming.
US consumer spending continuing to grow.
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