How Escalating Bond Yields Can Break 35-Year Trajectory Of Falling Interest Rates?

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by Viraj Shah
 
When Trump came to power, the dollar index rose by 4.5%. However, the trend for an overvalued dollar had only continued with the new President assumed office. This clearly wasn’t good news as Trump’s idea of manufacturing boosts and better economic growth would be hurt in an instance. Hence, President has now shown signs to cut down on the inflated dollar value and bring growth and manufacturing back home. However, a rising bond-yield could bring problems for investors as a 35-year trajectory of falling interest rates could be at stake in 2017.
Bond-yields, that have been hovering around lower rates since years have now started to rise. The 10-Year Treasury note went up to 2.62% in the middle of December 2016, as stock market enthusiasm started waning. In January 2017, too, the yields have been consistent, mostly averaging at 2.45%. The numbers suggest that investors are flocking towards bonds in recent times.
Is it a sign that markets may not remain positive anymore?
Head of the US Credit Strategies for Schroders, Wesley Sparks, commented that investors should opt for high-yielding bonds instead of government bonds in 2017. He is managing Schroder ISF Global High Yield Fund and suggested that a move towards high yielding funds could be an attractive option for the investors. He also goes on to say that if tax incentives go down for businesses, there would be an increase in debt issues and equities will take a blow in 2018. There could even be US recession following a government deficit.
The Great Rotation Theory, a great rule of thumb when researching in retrospect, will not prove a healthy alternative in current scenario. If money moves from bonds, it may not necessarily move towards stocks in equal proportion. Wall Street analysts, on the other hand, are sure that when the 35-year bull ride of bonds ends, stocks will be riding on the fast lane. Jeff Gundlach, founder of DoubleLine, suggested that treasuries will end a decade long bullish cycle by going over 3% in 2017.


A qualitative analysis of bonds and stocks shows that low inflation rates and lower bond yields will lead to a better average in stocks. Bond yields will rise for many reasons. Firstly, the Central Bank has been artificially controlling the interest rates at record lows for almost a decade. Borrowings too increased after recession. President Trump has proposed many fiscal actions, including the management of an overvalued dollar, which will further lead to a rise in bond yields.
What could happen?
The American economy is saturated with debt. If the bond yields rise, the cost of borrowing will increase too. Remember, many credit card debts and other loans are dependent on these debt interests to classify their own interest rates. If the government continues deficit spending, inflation will spike up while debt levels reach an all-time high. Some analysts are even calling it a Bond Bubble which will break soon and cause problems with the stocks as well. As of now, US stocks are showing considerable joy with Dow climbing over 20,000 as President Trump signs a few executive orders, related to the Keystone XL pipeline and the Dakota pipeline. The results of the turbulence may not be felt until late 2017 or 2018. Till then, investors are advised to hold on to their portfolios and wait a little more instead of making hasty decisions.
 

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Conclusion:
Bringing back Manufacturing and job growth are primary objectives of new administration. Hence, controlling inflation will be of outmost importance. However, investors should be cautious as far as investing in bonds considering higher yields.

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