Bond prices have been “under pressure” for months as investors have pondered the impact of higher interest rates on fixed income assets, but equities markets have been relatively benign by comparison.
Now some fund managers are warning equities too will feel the impact from rising bond yields, due to the debt on their books, while others take a more positive outlook, particularly on what they call the “goldilocks” US market.
Guy Miller, chief market strategist and head of macroeconomics at Zurich says: “Bonds have been under pressure for three or four months, really that has been centred on events in the US, where inflation has been above the Federal Reserve’s target, and services inflation, in particular, has been above the target.
“That has set the scene for investors to question the number of rate cuts that can happen, and then you add into that a new president with a series of policies that are potentially inflationary, and investors began to sell US government debt. The impact on gilts and on Eurozone government bonds has been collateral damage.”
He explains initially the view was that US equity markets could overcome this because of the potential tax cuts and deregulation under Donald Trump as president, which meant investors were willing to overlook higher discount rates as a result.
Trump’s policies are expected to benefit the technology sector, in which US equities have been particularly strong.
But Miller adds: “In recent weeks, there has been a realisation that lots of these companies have debt they will need to refinance, and that households face higher mortgage costs as a result of the higher yields, which impacts consumer demand.
“With that in mind, I can’t see equities moving much higher until bond yields stabilise.”
Miller feels bond yields could rise even further from here, and ultimately rise above 5 per cent.
However, while he believes equity market returns could be meagre, the asset class he regards as most likely to be negatively impacted is corporate bonds.
This is because the higher yields offered on government bonds reduce the incentive to take the extra credit risk associated with corporate debt.
Rob Starkey, portfolio manager at Schroders Investment Solutions, says bond and equity returns could become “more correlated” in the high yield environment.
He says: “There was a period where equities were defying gravity, rates were rising but equity markets were also rising.
“That is not normally how that works, it was an environment where bad news for the economy was treated as good news for equities, but perhaps since the start of 2025 we are seeing bad news be treated as bad news, and that has implications for both bonds and equities.”
Research from the equity desk at Bank of America examines which equity segments tend to perform well when bond yields are higher.
They concluded that industrial stocks, banks, energy companies and insurance companies are the European equity sectors which perform best in those market conditions.
Banks and insurance companies tend to profit from higher bond yields as they are required to retain a significant portion of their capital in liquid assets such as cash and bonds and higher yields mean they generate a better return from this part of their balance sheet.
Energy companies and industrial businesses tend to be able to withstand the impact of higher bond yields as they sell goods which have pricing power.
Goldilocks US market
Steven Bell, chief economist at Columbia Threadneedle, says equities typically underperformed in previous periods of rapidly rising bond yields if they happened during periods of higher inflation.
But the US economy looks to be in good shape currently, he adds.
He says: “One way we think about the impact on equities is the discount rate, and we look at the yield on US Tips [inflation linked bonds] as a good proxy for the discount rate, and while that yield has risen, it hasn’t actually gone up that much.
“We think the US market is goldilocks. In recent asset allocation meetings we have been discussing increasing our allocations to US equities.
“US companies have exceptional returns on equities, they simply make more money than comparable companies in other parts of the world.”
Large US technology stocks are long duration in nature and so more vulnerable to higher bond yields.
But Bell says: “While many would expect those companies’ earnings to go up in future, those businesses have earnings now, and the earnings they have now shorten the duration.”
When it comes to the UK, he says that if he were the decision maker, he would vote against an interest rate cut in March because “there are too many uncertainties around the impact of the increase in the minimum wage and the impact of higher employer national insurance contributions.”
david.thorpe@ft.com