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The Link Between Bond Yields and Risky Assets

Gold and oil relate to bond yields very differently 

The oil price drives inflation and rises when yields are rising. Gold does better when yields fall

Source: Bloomberg, CCBIS

One of the least understood aspects of financial markets is the link between bond yields and other asset markets.

We frequently read commentators who suggest that equities and other risk markets will take off once yields peak and start falling. That, unfortunately, is not how it works. In today’s note, we show the contemporaneous link between bond yields and other markets (as opposed to a delayed link). In other words, we show how other markets normally behave when bond yields are rising or falling. Using quarterly data since 1998, we compare the cumulative return of different assets in quarters when bond yields rose versus when they fell. The first set of charts compares oil and gold. Oil does best when yields are rising but once you think the bond yield has peaked, gold is normally a better option.

Risk assets do well until yields stop rising

Rising bond yields equal economic confidence. Equities and credit do well until yields peak

Source: Bloomberg, CCBIS

The second chart set of charts shows the contemporaneous link between bonds, equities and credit spreads. Equities and risky credit enjoy a rising rate environment; however, once bond yields peak, – spreads widen and equity markets usually fall.

Defensive sectors relish a falling yield environment

Note that real estate, being interest rate sensitive, can also perform well as yields decline

Source: Bloomberg, CCBIS

The last chart examines relative sector returns in both EM and in the US. The dark blue bars show sector relative performance when yields are rising. Unsurprisingly, cyclicals do well. However, once yields peak, the light bars show that defensives outperform. Healthcare and staples typically do best in EM while utilities are normally more defensive in the US market.


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