Interactive Investor

Why bond yields have risen so fast and what investors can do

Equity markets hate it when bond yields rise, but some experts think this might be a rare opportunity for investors to add a wide range of asset classes to diversified balanced portfolios.

4th October 2023 15:16

by Graeme Evans from interactive investor

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A calmer mood on Wall Street brought some relief today after higher global bond yields this week triggered a turbulent start to the final quarter of 2023.

The S&P 500 index, which closed 1.4% lower on Tuesday at its lowest level since May, opened in positive territory as the 10-year Treasury yield eased from last night’s post-2007 peak of 4.8%. The dollar index also weakened, having risen 7% from its July low.

Figures showing weaker-than-expected private sector job growth played a part in the improved mood, cooling fears that excessive demand for workers might force the Federal Reserve to make a final hike in US interest rates before the end of the year.

Deutsche Bank reported this morning that futures markets saw a 52% chance of another hike by December, near the highest level for the month since August.

Those expectations and the prospect of rates staying higher for longer in 2024 have fuelled bond yields on both sides of the Atlantic, with the UK’s 30-year gilt yield yesterday at its highest level since 2002 above 5%.

Higher yields diminish the investment appeal of income-bearing stocks such as utilities, and dent corporate profitability through rising borrowing costs. Worries over the impact of the bond sell-off yesterday sent the Vix index of volatility above 20 for the first time since May, and triggered a wider flight from risk that left the likes of Tesla (NASDAQ:TSLA) and Amazon (NASDAQ:AMZN) sharply lower.

Both mega-cap stocks were more than 1% higher in the early moments of today’s Wall Street session, with the Nasdaq Composite up by 0.5% after losing 1.9% yesterday.

The rise in US bond yields has accelerated since the Federal Reserve’s September meeting, when a dot plot of forecasts pointed to the potential for a smaller-than-expected 50 basis points of monetary policy easing in 2024.

UBS Global Wealth Management thinks that markets had previously been too confident in pricing a rapid easing of Federal Reserve policy.

It added today: “While we expect equity and bond market conditions to improve, we forecast choppy and range-bound trading in equity markets in the near term, as well as a reverse in the recent rise in longer duration yields.”

Rather than being due to inflation expectations, the bank said the rise in yields appears to be largely caused by technical forces at the long-end of the curve. In particular, the Fed’s shift from quantitative easing to quantitative tightening has removed a significant source of buying.

Overall, the bank expects economic trends to return to the fore: “Regardless of whether the landing is ultimately hard or soft, we think US and global economic activity will slow and inflation will moderate over the next year — boosting demand for high-quality bonds.”

It has told clients it believes this is an opportune moment to add to diversified balanced portfolios. “Despite near-term headwinds for stocks, we’re at a rare time when in our base case, we expect cash, bonds, stocks, and alternatives to all deliver reasonable returns.

“That’s both over the next six to 12 months, and the longer term. In our view, investors can tap into an attractive opportunity set across asset classes, position for durable returns for years to come, and mitigate the effect of potential risks.”

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