Expect global equity markets to stall as bond yields jump
Sudden rise in ‘real’ yields portends powerful headwinds
A big change in global bond markets occurred overnight when the yield on inflation-protected US Treasuries and inflation-indexed German bonds jumped about 5 basis points (0.05 percentage points). The rise in bond yields in December and January was due almost entirely to the inflation component of bond yields: As oil prices rose, the inflation component of global bond yields followed it, while the “real” (or inflation-protected) yield was little changed.
The jump in bond yields overnight came almost entirely from the “real” component. The trigger for the bond market route was a Sunday statement by Dutch central bank president Klaas Knot, who said that the European Central Bank’s “quantitative easing” program of buying government and corporate bonds had to end as soon as possible. Knot, who also sits on the ECB’s governing board, said, “The program has done what could realistically be expected of it,” echoing the long-stated view of German central bank chief Jens Weidmann, who also is an adviser to German Chancellor Angela Merkel.
The ECB’s aggressive easing program under its current president, Mario Draghi, pushed most European sovereign bond yields into negative territory. That was a boon to heavily-indebted southern European countries but a burden to northern European savers. It has to stop some time, and when it stops, European and global bond yields have to rise.
Monetary ease wasn’t the only reason for the global equity boom, but it surely contributed to it. Until the dust has settled in global bond markets, expect stock markets to face powerful headwinds. The rise in “real” yields is a long-overdue adjustment to higher global growth, and growth is good for stocks. But the short-term outlook for equities has shifted from positive to neutral.