On Wednesday, India’s benchmark 10-year government bond yields soared to a high of 6.66 per cent before falling to 6.60 per cent.
What has caused this increase? Rising crude oil prices, inflationary threats, and earlier-than-expected interest rate hikes indicated by the US Federal Reserve have all contributed to bond yields hardening. Rising bond yields, logically, have sparked anticipation that the Reserve Bank of India (RBI) may eventually abandon its accommodative policy and begin increasing interest rates.
What is the difference between a bond and a bond yield?
Bonds are simply loans made to a firm or the government. Throughout the loan’s term, the interest payments are virtually unchanged. Furthermore, if the borrower does not default, the principle is returned after the loan term.
Bond yield is the rate of return that an investor receives on a certain bond or government instrument.
Bond yields and prices are linked.
Bond prices rise and fall in response to changes in interest rates in an economy. Bond yields, on the other hand, fall/rise in response to this.
Bond yields and inflation expectations
As money moves from relatively safer investment bets to riskier equities, a stock market boom tends to raise yields. When inflationary pressures rise, however, investors tend to return to bond markets and sell shares.
What impact do bonds have on stock markets?
Before we get into how the share market is impacted by bonds and bond yields, you need one of the best trading accounts from a leading online stock broker like Zebu to capitalise on market changes. With a leading online trading platform, you can anticipate market moves and maximise your profits.
More on how bond yields affect the stock markets:
To calculate the expected rate of return, investors add the equity risk premium they seek to a risk-free rate when pricing equities. Defaulting to the long government bond yield is usually the simplest way to estimate the risk-free rate. Long bond yields are important to equities because of this.
Given that the risk-free rate is the long bond yield, a higher bond yield is unfavourable for equities, and vice versa. However, it’s important to recognise why bond rates are changing, not just the direction in which they’re changing.
Long bond yields reflect the economy’s growth and inflation mix. Bond yields normally rise when growth is robust. They also rise in response to rising inflation. However, the impact of these is different for stocks.
When growth is strong, the positive impact of larger cash flows or, more accurately, dividends more than outweighs the negative impact of higher yields, resulting in higher equity share values.
The difference between actual GDP growth and the 10-year bond yield corresponds well with stock prices. Indeed, share prices should be fine if GDP increases faster than bond yields in the next month.
If growth accelerates from here equities are likely to break this range on the upside, in line with the fundamental relationship.
How Should Investors Play It?
In the scenario that growth accelerates, investors can opt for rate-sensitive instruments like mid- and small-cap stocks and funds. However, if inflation makes a rapid return, you can go with reliable companies in solid sectors like technology, healthcare and FMCG.
Whatever your take is on bond yields and their correlation to the Indian markets, you need the best online trading platform to change your game plan. At Zebu, we have taken our expertise as one of the leading online stock brokers in India and created the best trading accounts and investment platform to seamlessly capitalise on any economic macro and invest in the best stocks and funds that you find reliable. To know more about our products and services, please get in touch with us.
