The relentless upward movements in yields on government bonds across the world that I mentioned in my article two weeks ago over concerns that central banks will keep interest rates ‘higher for longer’ in order to tame inflation, is having wide implications across stockmarkets.
In view of the inverse relationship between yields and prices, the sharp upturn in government bond yields implies a corresponding decline in bond prices especially for longer-term bonds. Meanwhile, equity markets have also staged a notable downturn from their highs at the start of the summer.
The yield on the 10-year US Treasury note jumped to just below the 4.9 per cent level last week (the highest level since June 2007) from circa 3.4 per cent at the start of April. The increase of 150 basis points implies a significant downturn in the price of US Treasuries. When reviewing the movements in US sovereign bonds over a slight longer timeframe, the crash in bond prices can be seen from the price of a 30-year Treasury note issued in May 2020 as it lost more than half its value and is now trading at about 45 per cent of par value.
Likewise, the yield on the German 10-year bund, which is the benchmark for the eurozone, surpassed the 3 per cent level last week from just over 2.1 per cent at the start of April. Italy’s benchmark 10-year bond yield surged to almost 5 per cent last week for the first time since Europe’s sovereign debt crisis raged 11 years ago.
The upward movements in yields across the eurozone is also directly impacting the performance of Malta Government Stocks. To put this into perspective, the price of the 1.8 per cent MGS 2051 (the 30-year bond issued in 2021) lost almost half of its value as the indicative price of this security quoted by the Central Bank last week was of 53.57 per cent. The extent of the decline in MGS prices can also be portrayed by reviewing the price of the 4.3 per cent MGS 2033 which is a good reference currently since it matures in 10 years’ time. Last week, the indicative price of this security was of 100.79 per cent which represents a decline of 35.74 percentage points from its all-time high of 136.53 per cent in April 2015.
Essentially, the yield on this 10-year MGS is currently at 4.2 per cent compared to a yield of below 1 per cent at the start of 2022. This is an extraordinary change in such a short period of time.
The intense moves across the bond markets over recent weeks may have surprised many analysts given concrete evidence that inflation in various parts of the world is easing consistently from the multi-decade highs registered last year. This clearly indicates that central banks are at, or near, the end of the current interest rate hiking cycle leading to a stronger probability that rates will eventually need to be cut.
However, the recent increase in oil and gas prices adds some upward pressure on inflation leading many central banks to warn that interest rates will remain on hold for a good part of 2024. In fact, economists are now only anticipating the first interest rate cuts to happen towards the end of next year as opposed to early 2024 until a short while ago.
Although equity markets have performed poorly as yields staged a remarkable upturn in recent weeks, economic growth and corporate earnings are the main factors that impinge on the long-term performance of share prices. This was evident for a good part of the first half of this year with equities rallying despite rising interest rates as economic growth and corporate earnings remaining surprisingly resilient. As such, the Q3 reporting season commencing in the US this week could either lead to further declines for equities or else trigger a modest rally into the year-end.
Amidst the market jitters over recent weeks coupled with the continued lacklustre activity on the Maltese stockmarket, there are multiple corporate actions taking place concurrently. Two of the larger bond issuers in Malta announced new bond offerings mainly to refinance bonds that are being redeemed in the weeks and months ahead. In view of the sudden changes in the interest rate environment and the impact on bond yields as described above, these issuers (AX Group plc and International Hotel Investments plc) also had to reflect this in the pricing of their new bonds with coupon rates now almost equivalent to the rates offered at the time of the issue of the original bonds exactly 10 years ago. This will naturally negatively impact the finance costs of these companies and all issuers in the future in view of the higher rates to bondholders and banks as opposed to the coupon rates of below 4 per cent until very recently.
Another major corporate action taking place at the moment is the rights issue by Lombard Bank of just under €50 million. This is an important and sizeable capital injection taking place and the response by the current shareholders could have important implications for the equity market in the weeks ahead as the bank will then offer any lapsed rights first to other existing shareholders and then to the investing public at large.
Although it is customary for all companies overseas to have a well-structured reporting season on a quarterly basis, the situation is different in Malta with only a few companies providing key figures and highlights on their financial performance on a quarterly basis since the regulatory requirement is for semi-annual reporting. Nonetheless, a few of the companies publish key financial information quarterly and provide market commentary on the main business developments which is important for regular followers of the Maltese capital market. In this respect, APS Bank plc have already confirmed that their Q3 numbers will be published on 26th October. The information being published in the weeks ahead by the various companies will undoubtedly continue to show the strong performance of the banks in this current favourable interest rate environment as well as the stronger-than-expected recovery across several other economic sectors which bodes well for all shareholders.
Meanwhile, the intensified conflict in the Middle East that erupted over the weekend is adding another dose of uncertainty within the ever-changing geo-political landscape. Despite this added dose of uncertainty, the recent pullback in equity markets together with the upturn in yields can present interest opportunities for long-term investors especially should bond yields begin to decline during the course of next year on expectations of future rate cuts.
Read more of Mr Rizzo’s insights at Rizzo Farrugia (Stockbrokers).
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