Moneycontrol Pro Panorama | The threat from higher bond yields 

If the uncertainty comes off in the near term, bond yields could start coming down and investors could quickly return to a risk-on mode.

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The 10-year US Treasury yields soaring to nearly 5 percent on Wednesday -- the highest since 2006 -- made headlines across the globe. A combination of escalating tensions in the war-ridden Middle-East and continued resilience in the US economy as reflected in retail, manufacturing and labour market data is accentuating fears of “higher-for-longer” trend in interest rates.

Obviously, equity markets are spooked. As US bond yields rose, Wall Street indices caved in signalling rising risk aversion among investors. The contagion spread to Asian equity markets that are flashing red today. Indian benchmarks, too, are jittery and weak.

Indeed, history shows that prolonged war has economic ramifications, albeit in varying degrees, for most nations. The two recent geopolitical events – the Hamas-Israel war and the Russia-Ukraine war -- are expected to stoke inflationary pressures that have, since the pandemic, puzzled central banks and policymakers. Deepening fault lines around the Middle East, in the near term, will keep oil prices elevated. The multiplier effect will be felt in the costs of manufacturing for some sectors, transport and logistics costs and finally in consumption.

In this context, the global fund managers’ survey by Bank of America points out that the biggest tail risk to equities is high inflation, which will keep central banks hawkish. High rates, with few economists even forecasting another rate hike, a global recession and hard landing will cast a cloud of gloom over equity markets.

But there could a silver lining, too. If the uncertainty comes off in the near term, bond yields could start coming down and investors could quickly return to a risk-on mode. Well, 56 percent of the fund managers in the survey expect lower bond yields in the next 12 months, which is the highest share of respondents on record. “That’s a powerful bullish signal,” says Manas Chakravarty in this article. If so, will the markets enjoy the traditional Santa rally this year?

For now, the global allocation to equities is still cautious. Investors are selling off. There is higher proportion of cash with investors and investors are moving towards safe havens such as gold.

However, Indian investors have reason for some cheer. While inflation is not anywhere close to what policymakers are targeting, it is showing signs of moderating. In fact, the Indian economy has been displaying a relatively higher degree of stability compared to its Asian peers. Even the Bank of America survey shows a net 28 per cent of investors overweight on Indian equities, second only to Japan. Interestingly, the Chinese market is at the bottom of the pack.

For now, all eyes are on Fed Chair Jerome Powell's speech in New York today, which should provide clues to the markets on the 'higher for longer' theme.

Investing insights from our research team

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(These are published every trading day before markets open and can be read on the app).

Vatsala KamatMoneycontrol Pro