Bond yields influence the stock market in different ways at different times. Investors and traders need to be aware of economic and market conditions to understand the constantly evolving relationship between bond yields and the stock market.
Changes in the Economy
When the economy is healthy, rising interest rates and bond yields are bullish for stocks, as it implies an increase in the return that investors are seeking for their money. When the economy is not healthy, falling interest rates are bullish for stocks as it is stimulative for assets. Interest rates are the largest variable in determining bond yields.
During periods of economic expansion, bonds and the stock market trade inversely as they are competing for capital. Selling in the stock market leads to lower yields as money moves into the bond market. Stock market rallies lead to rising yields as money moves from the safety of the bond market to riskier stocks. Under these circumstances, when optimism about the economy grows, money moves into the stock market as it is more leveraged to economic growth. Additionally, economic growth also carries with it inflation risk, which erodes the value of bonds.
However, there are periods in time when bonds and stocks move together. This tends to happen early in economic recoveries when inflationary pressures are weak and central banks are committed to low interest rates to stimulate the economy. Until the economy begins to grow without the aid of monetary policy or capacity utilization reaches maximum levels where inflation becomes a threat, bonds and stocks move together in response to the combination of mild economic growth and low interest rates.
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