A fall/rise in interest rates in an economy pushes up/pulls down bond prices. However, bond yields fall/rise in this situation.
This happens because if RBI, for example, decides to increase interest rates, the bond’s price (which is offering a similar return as the current interest rates) would fall because its coupon payment is less attractive now on a relative basis. Therefore, investors would chase new bonds with better risk-free return.
Inflation expectation and bond yields
A rally in the stock market tends to raise yields as money moves from the relatively safer investment bet to riskier equities. However, if the inflationary pressures begin to look up, investors tend to move back to bond markets and dump equities.
As the US bond yields, surge in the global markets it likely to raise the alarm bells for market. Changes in bond yields overseas enable investors to assess risk in the equity markets going forward, with any rise reducing the profitability for lenders on their bond holdings.
Perspective:
Bond yields are determinants that drive the equity valuations. An inverse relationship between the two variable indicates when bond yield increases, equity markets decline and vice versa. Bond yields are the opportunity cost of investing in equities. The yield on bonds is the risk-free rate for calculating the cost of capital. As bond yield increases the cost of capital of equity increases which indicates a higher rate of discount for the future cash flows which reduces the equity valuations.
ERC Team
