How does the Bond Market affect the Stock Market?
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M$2 Answers
The second is that for a specific company, its bonds show something about the health of the company. If the company is doing well, its bonds will probably go up in price, as more people have confidence the bonds will not become worthless through the company's failure. This pushes down the yield on that company's bond, and signals that the stock is likely to go up. Conversely, if a company hits a rough patch, its bond yield will likely go up, and that will signal a probably downturn in its stock price.
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M$
When interest rates rise, the demand for capital falls yet investors are willing to provide more capital at the higher rates, which tends to lure capital away from the stock market. Also, when companies' future earnings are discounted to their present value at a higher interest rate, their present value is less. Therefor, investors tend to sell stocks in anticipation of rising interest rates and much of that capital will be invested in bonds. And, of course, the situation reverses when interest rates fall.
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M$
What makes things tougher on banks is that they're also afraid to lend to customers while the economy is weak, for fear of having the debt go bad and losing the principle. In addition, the credit card business is no longer anywhere near as lucrative as it used to be a few years back. More bad debts there, and a new consumer protection law that limits the bank's bad behavior (good for everyone in the long term, but problematical for the banks' profits in the short term).
How big do you think the Bond Market bubble is? Or in other words, how profit pressure could occur, if interest rates increase 20-30 percent from where they are now.
http://www.bloomberg.com/intro_markets.html
U.S. 10-Year Treasury 3.42
If rates rose to 4.32 % (30% increase) then loans connect with the US Treasure would rise. I expect the interest rate rise would create pressure on the mortgage back securities and directly influence variable rate loan rates to rise. For individuals, shifting to the fix rate, they would escape, if they can maintain a job. Foreclosure rates would continue to rise. Banks would be under greater pressure to shed the risk. More assets on the market would depress price. Inflation will make price more expensive in durables and services, further weakening investment.
Banks have said they have plenty of money to loan to large and stable customers. Credit would continue to tighten as money becomes more expensive to borrow.
I'm not an expert, so take the following with a grain of salt. A dollar rally would not affect domestic investors directly. However, it would make our bonds and stocks more expensive for foreign investors. This might incline those investors to take some profits, especially if they expect the dollar rally to be short-lived. In addition, a dollar rally would make our products more expensive overseas, implying a likely reduction in profits for US companies deriving a significant fraction of their income from foreign sales.
As for the bond market being the next bubble, I don't know. I have read that the yield curve is no longer flat primarily due to the Fed keeping short term rates especially low to help economic recovery. How long the Fed can and will choose to keep doing so is very uncertain. Once they stop, short term rates will climb, pressuring bank profits. It will also slow economic activity which depends on cheap credit. Higher rates will tend to depress bond principle values.
You raise the most important issue of rising interest rates, "pressure on bank profits". Banks are extremely weak. Banks are intensely interconnected. When one large bank fails, it has a cascade affect on smaller banks. Small profit margins have pressured many banks out of business. There is a perceived fear that banks are too weak. The fed is governing closely the policies of the banks. However, as profit margins decrease, the fed will act as a lender of last resort and not a new customer.
How will a dollar rally affect the Bond Market?
Is the Bond Market the next big bubble?