LIVE MARKETS-Rising bond yields: impact on equities

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RISING BOND YIELDS: IMPACT ON EQUITIES

A rise in longer-dated bond yields is starting to grab the attention of investors, and while equities are not showing too many signs of worry, risks are starting to grow.

Yields have risen this week on concerns about fiscal sustainability as the U.S. House passed Trump's massive tax cut and spending bill. In response, the U.S. 10-year yield US10YT=RR rose above 4.5%. The 30-year US30YT=RR is holding above 5%.

"Rates have touched the pain threshold for equities," write Barclays equity strategists in a note.

"This time, yields are no longer moving up for the right reason, but largely because of rising term premia, which is not something equities are happy about."

But, so far, equities are mostly overlooking rising yields. The STOXX 600 .STOXX is up 0.4% this week and heading for its sixth straight weekly rise. The S&P .SPX is down 2% this week but is still 3% above its pre-Liberation day level and over 20% higher than its April low.

GROWTH IS KEY

Both Citi and Barclays equity strategists believe growth is important when determining the impact rising rates will have on equities.

"Equities can typically shrug off higher rates if those higher rates are accompanied by solid global growth outcomes and contained inflation," Citi says.

"When higher rates are instead accompanied by slowing growth and more stubborn inflation, this can become more problematic for equity market returns."

For that reason, Barclays favours companies with a strong balance sheet.

"Bond vigilantes are likely to keep equity markets on edge, until they are convinced that the spending cuts are large enough to keep deficits under control, and/or growth is strong enough for earnings to cushion valuations against higher rates," Barclays says.

"In such a scenario, we believe higher quality balance sheet stocks should be favoured, and note that their performance has lagged the recent increase in credit spreads."

(Samuel Indyk)

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