Bond Yields in the Face of QE Tapering

As the equities market is being shaken by the prospect of QE from the Fed, the bond market also faces the possibility of large moves in the coming months as investors try to understand what will happen when the taper kicks in. A release of estimates from Morgan Stanley's Matthew Hornbach puts forward seven different scenarios that could play out, based on when the taper will start. He also goes on to say that his bet lies with the taper starting in December of this year.

Even with the recent rise in 10-year treasury yields to 2.16% the month of May finished with solid gains for the Dow Jones Industrial Average, closing above 15,000. Many experts place warning levels of yields near 6%, so there is still a large area to cover before we start to see a threat.

The OECD, the Organization for Economic Co-Operation and Development, warned on the 29th of May that a withdrawal from the bond markets via the QE tapering would cause yields to spike and further the global slowdown. As said by Pier Carlo Padoan, OECD's deputy secretary-general and chief economist, "exit from unconventional monetary policy, when needed, may be difficult to manage and less smooth than desirable, possibly leading to sharp rises in bond yields and serious negative consequences for growth in a number of advanced and emerging economies."

Goldman Sachs believes that equities are going to rise with bond yields, due to the key distinction that the rise in yields in May were not due to inflation fears, but rather to the changes in monetary policy and expectations of economic growth. Three reasons for the bullish view are as follows: 1) S&P 500 valuation has exhibited positive correlation with 10-year yields since 2000 2) A large equity — bond yield gap can tolerate higher bond yields 3) A better growth outlook is good for EPS growth”