US Treasury yields slip from highs as traders brace for stock sell-off

US Treasury yields slip from highs as traders brace for stock sell-off

Germany's 10-year bond yield, the benchmark for the bloc, fell as low as 0.671 percent, down 7 basis points on the day and was set to close the day at 0.69 percent, still well below Monday's more-than-two-year high of 0.774 percent.

In one sign of a shift underway, a measure of expected market turbulence, the CBOE Volatility Index, jumped by more than 15 percent Friday.

Analysts are attributing this fall to rising global bond yields, which have unsettled investors and central banks the world over. The bond bear market has begun in tooth and claw. So US bonds yields are rising, giving equities a run for money.

Take the Indian context.

The Dow is down 8.5 percent from the record high it hit in late January.

The smaller the difference, the lesser ERP investors receive, making so-called risk-free assets such as bonds more attractive.

Opportunity cost is nothing but the cost of next best alternative - the cost of foregoing one investment option in favour of the other.

Equity investments are deemed risky. Treasuries are the closest thing out there to a risk-free asset because there's an assumption that the USA will never default on its obligations.

At prevailing bond yield of 7.56 per cent, one would then require 13.56 per cent (adding 6 per cent risk premium) on equity to make a switch from bonds. And the more bond yields rise, the more will be this opportunity cost.

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The downdraft raised fresh anxieties among Americans who have seen their retirement savings and household worth march steadily higher without any of the gyrations that are part of a normal market cycle. The BEER ratio (bond yield/equity yield) now stands at 1.85, suggesting that equities are overvalued.

"It looks to me like a typical type of scenario when you see a single stock flash crash where you'll see bids just disappear, stop orders get kicked", said Joe Saluzzi, co-manager of trading at Themis Trading in Chatham, New Jersey.

Also on Tuesday, Germany sold just over 800 million euros of inflation-linked bonds maturing in 2026, while Austria sold 700 million euros of five-year bonds. Central banks wanted to heal their economies. The unemployment rate remained at a 17-year low of 4.1% for the fourth straight month in January. European Central Bank too picked up even junk bonds from various countries.

Monetary policy decisions are due in Australia, Russia, India, Brazil, Poland, Romania, the U.K., New Zealand, Serbia, Peru, and the Philippines.

The slump began Friday as investors anxious that higher inflation and interest rates could derail the long-running rally. "Since last autumn, investors had been betting on the goldilocks economy - solid economic expansion, improving corporate earnings and stable inflation".

Moderate inflation is a healthy component of an economy.

After a decade of near zero real income growth across the developed world, workers may well be seeing wages rising again at last and global markets do not like it. Why? And investors anxious it could prompt the Federal Reserve to raise interest rates faster than expected.

Friday's markets went tumbling on good economic news as the Labor Department reported a 2.9 percent increase in hourly earnings. Inflation has an inverse relation with bond prices, and positive relation with bond yields. "Investors are waking up to the fact that we won't have low interest rates forever". Higher borrowing rates over time could undercut corporate earnings as well as stock prices. "There is no doubt interest rates will rise and liquidity will be withdrawn but it will be gradual and calibrated in nature", said Shah of Kotak Mutual Fund.

However, rising bonds does not always lead to poor equity performance. "Even at 2.85 percent, the 10-year's yield is simply back to where it was four years ago. Most of the recent moves were driven by the United States, with Treasury yields trading at nearly 2.90 percent, with at least probably some marginal willingness on behalf of investors to scale into the market again at those levels".

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