How rising US bond yields are affecting stocks

Published: March 24, 2021 at 11:00 am

Last Updated on December 29, 2021 at 6:09 pm

If you are actively following the financial news nowadays, you might have read that ‘US Bond Yields Rising’ and that this is causing the volatility that we see currently in the Indian Stock Market. This article will try to understand what US Bond Yields are, why they are rising, and how exactly it affects the Indian, or indeed any other, stock market.

About the author: Arjun Budhraja is an MBA in finance with fifteen years of experience in the finance sector. He currently is an entrance exam CAT, GMAT, Law, BBA, etc.) coach. His interests include Personal Finance and Equity Markets. The opinions expressed in the article are solely the author’s and do not reflect the opinions of freefincal.

Defining Bonds & Bond Yields: A Bond is basically a piece of paper, a contract, under which the borrower (in this case, the US Government) borrows money from a lender and promises 2 things – to pay a certain rate of interest every year (or every quarter/ every 6 months) and to return the borrowed amount in full after the end of the borrowing period.

Let’s say US Government borrows $100 from Adam at the interest rate of 2% per year for a period of 5 years. Now, they will pay $2 each at the end of Year 1, Year2, Year 3, and Year 4. At the end of the 5th year, they will pay back $102 ($2 interest & $100 original amount).

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Further, in this example, the yield (or the return) that Adam gets in Year 1 is 2%, calculated by dividing the interest received by the Bond’s price (2 divided by 100).

Now let us consider a scenario where Adam needs his money back for some purpose after only 2 years of lending it. The government would not consider this request right now since they have issued bonds for 5 years and are not legally required to repay them before the end of those 5 years.

So Adam can’t get his money back from the government before the end of 5 years. Instead, he would search for some other buyer. At this point, 3 possibilities are there:

  1. Interest Rate is the same at 2% – In this case, Adam could easily find a buyer willing to pay $100 for the bond he owns since the new investor would not differentiate between the bond that Adam owns and a new one issued by the US Government. This is because the new investor’s yield (return on capital) is the same.
  2. The interest rate has gone up to 4% – In this case, Adam would have a problem. The bond that he owns has a yield of only 2%, whereas an investor can easily lend the money to the US Government at a 4% return on new bonds. Any new investor would prefer to buy a new bond for $100 being issued by the US Government and receive $4 as interest rather than buy Adam’s bond for $100 and earn only $2.
  3. This would mean that Adam would have to sell his bond at $50 to match the 4% yield offered by the new bonds of the US government. This will lead to a big loss for Adam if he decides to sell. However, if he does not sell, he can receive $2 every year and $100 at the end of his 5 years.
  4. Interest Rate has reduced to 1% – Now Adam would stand to gain considerably. He can sell his bond for $200, and still, the yield would be the same for a new investor. Here, it is in the interest of Adam to sell his bond and gain $100 immediately.

Of course, I have taken extreme examples here to explain the concept. Normally, interest rates would move much slower, especially under normal circumstances.

Bond Yields can also change based on Demand & Supply. Let’s try to understand this with examples too. Let’s assume that the US government has issued bonds only to Adam and that there are no other people or entities who own US Bonds.

Next, assume that a new investor, let’s call her Eve, wants to invest in US bonds. This could be for numerous reasons – for example, she feels that US bonds are the safest options for her right now for investing her money.

So Eve decides to contact Adam for selling his bonds to her. Adam does not want to do so. So, Eve offers to pay him $110 for his bonds. Adam thinks that it is a better deal for him to sell his bonds for $110 and gain $10 rather than wait for 5 years to receive an interest of $10 ($2 for 5 years). So he sells his bonds to Eve.

Now, calculating the yield for Eve, we will find that the yield that she receives is now 1.82% ($2/$110) than the 2% that Adam was receiving.

Vice versa, if Adam wants to sell his bonds, there are very few buyers in the market. He can offer his bonds for a price of $90 instead of $100 that was their initial value in that scenario. For the new buyer, the yield would be 2.22% ($2/$90)

Now, let us see what is currently happening in the US. For that, we need to look at the graph of US Bond Yields in the past 5 years, especially in the last 6 months. You might notice that there has been a significant increase in the Bond Yields in this 6 month period.

US 10-year bond yield chart from
US 10-year bond yield chart from

What does this mean? – rising yields would attract a lot of investors to invest in these US Bonds. This is because US Bonds are considered to be amongst the safest investment opportunities as there is almost a zero risk of default, and a rising return on these investments along with almost zero risk makes them lucrative.

How This Affects Stock Prices? An investor who is invested in stocks deals with the risk of loss as stock prices can significantly lower than the purchase price. There are numerous ways of defining this risk in terms of numbers.

Let us take an easy example. I bought a stock for Rs. 100 with the expectation that it would go up to Rs. 105 within some time. But considering that it can also go down if the price goes below 97, I would sell the stock and book a loss instead of risking losing more money as the stock price keeps on going down. So, my potential risk is Rs. 3 and the potential reward is Rs. 5.

Now, I compare my investment in stocks with the US Bond yield and see that I could earn a return of 1.6% with almost zero risk. This risk is very close to zero because even if the US government runs out of money to pay me, they can easily print new money and repay.

Another risk that an investor from the US faces while investing in Indian equities is Foreign Exchange Risk.

For example, in Jan. 2021, Elon decides to invest $100 into the Indian stock market. First, he will have to convert his US Dollars to Indian Rupees as transactions in Indian stock markets would happen only in Indian Rupee. Let’s say he gets Rs. 7000 for his $100. On 1 Jan., Elon invests this money in Nifty. 3 months later, on 31 March 2021, he notices that his 7000 has become 7500. Happy to be seeing a profit, Elon decides to sell and then withdraw his money. When he converts Rupees back to US Dollars, he sees that the price of 1 Dollar is now Rs. 75. So, what will happen that he will receive only $100 for his Rs. 7500.

As an investor, I might decide that it is better to earn a 1.6% yield taking only a minimal risk in US Bonds instead of investing in Indian equities where I might get a better return. Still, I am also taking 2 extra risks – the risk of loss in value and Foreign Exchange risk.

If several investors decide to do this, it will lead to a significantly increased supply and decreased demand in the Indian Stock market, leading to lower prices. Also, given that Indian stock markets are near lifetime highs, large investors have a big incentive to book the profits and reinvest their money in safer US Bonds.

What should you do? As an investor in the Indian Stock Markets, I would keep one eye on the rising Bond Yields in the US and another eye on the USD-INR rate. If there is a significant weakening of the Rupee, it can mean that Rupees are being sold to buy Dollars to invest them in the US. 

We are still not seeing any massive selloff in Indian equities, and we are still quite near to all-time highs. So, no need to be afraid, but one must definitely be cautious.

Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)