“What are you reading so intently? Is it about equity markets again?” Pragati asked her friend, Shreyja

“Actually, I am reading about bonds and their relationship with stocks. How do bond yields affect the stock market? Why do bond yields rise when stocks fall? These are just a few questions I am trying to figure out,” Shreyja replied.

“Okay, but then why do you look so lost?”

“Because the relation between bond yields and stock markets is just as confusing as your and Arpit’s relationship was in college,” whines Shreyja.

“Not fair! The relation between bond yields and stock markets isn’t all that complicated,” declares Pragati.

“Care to enlighten me on bond yields vs stock prices, then?”

How do bond yields affect the stock market?

When you buy bonds, you are essentially lending money to the company or government that has issued the bond. In return, you receive coupons or interest payments, and these are termed as bond yields. Despite belonging to different asset classes, bonds and stocks share a relationship that has been seen time and again in the markets through bond yields and stock prices. Bond yields tend to rise when stock prices fall. Let’s explore why this happens.

Why do bond yields rise when stocks fall?

To understand the relation between bond yields and stock prices, it’s important to first understand the relation between bond yields and bond prices. When bond yields rise, bond prices in the market fall. This is because investors would want to invest in newly issued bonds at higher interest rates and the demand for the old bonds with the lower yields falls, pushing down the price. Hence, bond yields and bond prices share an inverse relation.

When inflation is on the rise, the central bank applies contractionary monetary policy and raises interest rates. The central bank does so to make borrowing costlier and discourage spending. In such a situation, the stock markets are not left unimpacted. Rising interest rates impact the stock markets in two primary ways. First, as the bond yield increases, it makes bonds more attractive investment options than equity markets. If bond yield rises to a point that is close to or higher than the returns of stocks, investors will withdraw funds from their stock investments and flock to bonds.

The second impact is a little more subtle or indirect. In a rising interest rate environment, companies find it harder to pursue new projects to grow and expand as the cost of borrowing has gone up. They can either continue to borrow high-cost debt or pause their projects. Either way, their financials are impacted, which is reflected in their valuation and stock prices.

Bond yields and stock prices: Key takeaways

Bonds and stocks are two securities that do not move in tandem. As bond yields rise, the stock prices fall. This is because they fulfil different investor needs and carry different risks. Hence, economic factors impact each of them differently. Due to this, it’s essential to have a well-diversified portfolio with both debt and equity asset allocation.

Disclaimer:

_{** All articles, columns, news, market updates, opinions and such other similar materials (“hereby referred to as Content”) published on Kotak Cherry (“hereby referred to as Platform”) is for information purpose only. The views and opinions expressed in this Content published on this Platform do not constitute the views of  Kotak Investment Advisors Limited, its parent company or its subsidiaries group companies and its affiliates (“hereby referred to as Kotak Group or Kotak”). The Kotak Group makes no warranty of any kind with respect to the accuracy, reasonableness and/or completeness of the Content published on this Platform. The information contained in this Content published is sourced from external sources and internal means, which includes the information developed by outsourced content writers and in-house writers and editors of the Kotak Group for the benefit of the customers and it does not constitute any advice from the Kotak Group. Also, all such Content published on this Platform shall not be construed as legal advice from the Kotak Group. All customers should before dealing and or transacting in any of the products or taking any investment decision based on the information referred to in this Content, shall make their own investigation and seek appropriate professional advice.}

_{Such Content published on this platform is only for knowledge and learning purpose and is informative in nature and shall not constitute an investment advice under SEBI (Investment Advisory) Regulations, 2013. The Content published shall also not be construed as a research report as per the SEBI (Research Analyst) Regulations, 2014.}

_{Kotak Group and any of its officers, directors, personnel and employees, shall not be held responsible or liable for any loss, damage of any nature, including but not limited to direct, indirect, punitive, special, exemplary, consequential, due to reliance on or use of any information contained herein.}

_{No part of this Content published on this Platform may be duplicated in whole or in part in any form and or redistributed without the prior written consent of Kotak. The Content published on this Platform should not be reproduced or disseminated to anyone else without the prior written consent of Kotak.}