The fixed-income market dwarfs the size of the equity market. The diversity of debt issuers, from sovereign, supranational, to corporate ones, is huge.
Retail traders’ participation in the fixed-income market, though, is light. Increased costs, illiquid markets, plus lack of knowledge keep traders and investors from the retail community at bay.
However, no one can stop a trader from interpreting the moves in the fixed-income market and the implications of various rates. The benchmark for a risk-free rate in the United States and the entire world as well is the yield on the U.S. Treasury bonds.
Why Are Higher Yields a Game-Changer?
A bond, like the U.S. 10-year Treasury bond, has a price and a yield. They have an inverse relationship – the bigger the price, the lower the yield. Or, the lower the price of a bond, the higher the yield.
Bonds are one of the vehicles used by central banks to conduct monetary policy. When easing the monetary policy, central banks buy bonds from commercial banks and release cash, which finds its way into the real economy through lending to businesses and the population. This way, the monetary base expands. The opposite happens when the central bank is tightening.
The recent monetary policy actions from central banks around the world led to depressing yields. Instead of buying bonds, investors switched to equities for the simple reason that the yield to maturity was too low or declining or even negative in some cases.
That came to an abrupt end recently. As the chart above shows, the yields on the benchmark rate rose dramatically in the last trading days of February. What was the market’s reaction? A sharp selloff in the stock market indices and a strong bounce in the dollar.
The problem for financial markets is not that the yields are rising. Such a phenomenon is normal during an economic recovery. After all, we all want economic recovery, so why being spooked by the first sign that confirms it?
The explanation comes from the extent of the move. In other words, it is not the rise of the yields that is worrisome, but the pace of the bond yield increase.
A quick comparison with historical levels tells us that such spikes happened during the 2013 taper tantrum, the 2015 Bund tantrum, or even during the post-2106 election reflation theme. Are we in for a similar event in the months ahead?