Generally, investors keep their eyes and ears focused on all the narratives of what Equity markets are telling them and totally ignore the cues given by the Bond Markets. Unfortunately, what they fail to realise is that Bond market indicators are ahead and equity markets take guidance from them and react or follow the cues given by the bond markets.
Something similar is panning out currently. Post Trump Tariff tantrum, global equity markets nose dived in the first half of April 2025 but had a V shaped recovery thereafter. Without any cues from the equity markets, yesterday Nasdaq closed lower by 1.41%, S&P500 closed lower by 1.61%. What was brewing behind the scenes was the rising yields across the globe (including US and Japan) that spooked equity investors.
Let us analyze how bond market turmoil can disturb the apple cart of equity markets and why?
- High leverage players like Hedge Funds borrow from nations where interest rates are lower and invest in nations with higher interest rates or equities where they get higher yields. The difference they earn is CASH CARRY ARBITRAGE. This money is ruthless and emotionless and only understands yields
- On Monday, Japanese Prime Minister created a stir in the global financial markets by stating that Japanese economy was worse than that of Greece. Japan’s Debt to GDP ratio is extremely high at 216%. Lot of funds used to flow through CASH CARRY trades by borrowing in Japan (where interest rates were lower till last year) and funds used to be deployed in markets like US and emerging market equities. Japanese 30-year Bond yields are at record level of 3.18%
- Something similar is playing out in US debt markets as well. Burgeoning fiscal deficit, growing Govt debt (upwards of $36 trln and growing), uncertainty due to Trump Tariffs and Tax cut proposals, US 10-year Bond yields have spiked to a record level of 4.60%- and 30-year yields have spiked above 5.10%
- Yesterday’s auction of US 20-year bond cleared at a yield of 5.047% (24 bps higher than last month’s auction)
- More than the Bond yield, it was TAIL that set off alarm bells. TAIL is the gap between the market’s expected rate just before the auction and the actual rate the treasury ends up paying. This auction had a TAIL of 1.2 bps, its worst in over a year
- This created ripples in equity markets as well – when S&P tanked by 1.6% and Nasdaq tanked by 1.41%/ This was not triggered by earnings or geo political events, but more fundamental reasons viz.....
The COST OF MONEY changed fast and went Higher – Its implications:
- When treasury yields spike, all borrowings become more expensive from mortgages, to credit cards, to car loans to corporate loans
- This also impacts the way we value stocks: when interest rates rise, value of future profits falls. That is because investors discount future earnings based on prevailing rates
- When risk free yields jump to 5%, bar for stocks to look attractive gets raised. Treasuries look more compelling investment vehicles than stocks and hence capital rotates from equity to debt
- Rising debt yields and cost of borrowing has a ripple and a cascading effect on the real economy when consumers postpone their purchases of buying houses, cars, non-essential items. Thereby, slowing economic growth when consumer confidence fades
- Highly leveraged corporate balance sheets look very fragile with probability of bankruptcies rise as there will be impact on their earnings, albeit with some time lag
- Biggest borrowers balance sheets also go for a toss viz. Government borrowing costs. Half of fiscal deficit of US Govt goes towards debt servicing (interest burden for the first time in US Budget is higher than their Defence budget). Any additional Govt borrowing gets diverted to debt servicing rather than towards productive use of economic development
- In the bargain, investors lose faith in fiat currencies, reason why real and hard assets like Gold and Silver are at an all-time high – another rotation of asset classes from equity to precious metals
- Ideally, at such junctures of chaos, uncertainty, higher yields, geo political events, funds move towards safe-haven assets viz. US Treasuries and Precious Metals. However, due to Trump Tariffs, de-dollarization drives post sanction against Russia and confiscation of their dollar assets outside Russia, most global investors (Japan and China being the biggest holders of US treasuries so far) are dumping US treasuries and moving towards stacking precious metals. Reason why the so called safe-haven US treasury yields are spiking instead of softening
- Last week even Moody’s has downgraded US credit outlook
- US has huge amounts of debt maturing this year and over next few years (running into trillions of dollars) that needs to be refinanced on maturities. They will have difficulty to find buyers at current yields, and this may prompt US treasury yields to spike even further
- This will have a very devastating impact on Global equity markets, especially in emerging markets like India where FIIs will start pulling out funds once again
My suggestion and conclusion are to stop looking at narratives of equity markets only. Look beyond to debt markets, movement in Crude Oil prices, rates of Precious Metals and some of the important commodities like copper. These are singing a different song and giving us just the diverse narrative than what equity markets are singing
(Some inputs from StockMarket.News and Prithpal Singh - Aequitas)