Do you know how rising bond yields impact equity market?

Bond yields indicate the returns investors earn from holding government or corporate bonds and serve as a crucial measure of interest rate expectations in the economy.

Lately, the surge in global bond yields has raised significant concerns for financial markets amid ongoing inflationary anxieties, geopolitical conflicts, and expectations of elevated interest rates.

The increase in the US 10-year Treasury yield, which has exceeded 4.6%, has bolstered the dollar and diminished global risk appetite. Escalating yields raise borrowing costs, put pressure on equity valuations, and prompt capital flight from emerging markets such as India.

Additionally, rising crude oil prices driven by US-Iran tensions have further fueled inflation concerns and amplified market volatility.

Why do bond yields rise and fall?

Bond yields move based on inflation expectations, interest rate outlook, economic growth and investor demand for safe assets. One of the most important concepts in the bond market is that bond prices and bond yields move inversely. When bond prices fall, yields rise, and when bond prices rise, yields decline.

Bond yields usually rise when inflation increases because investors demand better returns to compensate for the loss in purchasing power. Yields also rise when central banks such as the RBI or the US Federal Reserve raise interest rates, as newly issued bonds offer better returns than older, lower-yield bonds. Strong economic growth, higher government borrowing and surging oil prices can also push yields higher by increasing inflation concerns.

On the other hand, bond yields fall when inflation cools, growth slows, or central banks signal interest rate cuts. During periods of uncertainty, investors often allocate capital to government bonds, which are considered safer assets. This higher demand pushes bond prices up and yields lower.

Bond yields are closely tracked because they influence borrowing costs, stock market sentiment, currencies and capital flows. Rising yields can pressure equities and weaken emerging-market currencies, such as the rupee, while falling yields generally support economic growth and financial markets.

How does rising bond yield impact banks?

According to Sunny Agrawal - Head of Fundamental Research at SBI Securities, rising bond yields could create near-term pressure on banks, particularly PSU banks, many of which hold sizeable government bond portfolios in their treasury books. Since bond prices move inversely to yields, an increase in yields leads to a decline in bond prices, resulting in mark-to-market (MTM) losses on investment portfolios.

Agrawal noted that these are largely notional losses rather than actual cash outflows. However, under MTM accounting norms, banks are required to reflect gains or losses from bond portfolio movements in their quarterly earnings, which can weigh on treasury income and reported profitability. He added that rising yields may also signal expectations of higher inflation or a tighter RBI monetary policy, which could affect credit growth and borrowing costs across the banking system if rates move higher.

Meanwhile, Tushar Badjate, Director of Badjate Stock Shares Pvt Ltd, said rising bond yields generally have a mixed impact on banks, with short-term pain arising from treasury portfolios and medium-term benefits potentially arising from better lending margins.

Badjate explained that when yields rise, bond prices fall, leading to MTM losses on government securities held by banks. However, over time, if lending rates reprice faster than deposit costs, banks can witness an improvement in net interest margins (NIMs), particularly those with a high share of floating-rate loans.

He added that the pace of the yield increase remains the key factor. A gradual rise in yields driven by economic growth is usually manageable and may eventually support profitability, while a sharp spike in yields could hurt credit demand, weaken borrowing appetite and increase stress across borrowers, creating broader risks for the banking sector.

How does rising US treasury yields impact Indian equity markets?

Mohit Gulati, CIO and managing partner of ITI Growth Opportunities Fund, explained that the US Treasury yields are basically the world’s gravity meter for money. When yields rise, global investors suddenly get paid more to sit safely in American bonds, so riskier markets like India can see foreign money slow down or move out temporarily.

According to Gulati, for Indian equities, the impact is usually felt first in rate-sensitive sectors like IT and banks, as well as in high-valuation, growth stocks. A sharp rise in US yields can also pressure the rupee and tighten global liquidity.

“That said, India is no longer just a ‘risk-on trade’. Strong domestic SIP flows and improving economic fundamentals now act like shock absorbers. So while rising US yields can create volatility and compression in valuations, they don’t automatically derail the long-term India story,” added Gulati.

Does rising bond yields pressure corporate borrowing costs and equity valuations?

According to Sunny Agrawal, Head of Fundamental Research at SBI Securities, said, the rise in bond yields essentially indicates that interest rates in the economy are moving higher. From an equity market perspective, this has two key implications.

First, higher bond yields translate into a higher cost of borrowing for corporates. Whenever companies refinance existing debt, raise fresh borrowings, or service loans linked to benchmark lending rates such as MCLR, the cost of capital tends to increase. As a result, finance costs for listed corporates are likely to rise, potentially affecting profitability going forward.

Second, rising bond yields also push up the risk-free rate in the financial system. In valuation terms, a higher risk-free rate increases the discounting factor used in equity valuation models. The moment the discount rate rises, the present value or fair valuation of future cash flows declines. Therefore, from a theoretical and financial modelling standpoint, rising bond yields generally lead to moderation in equity valuations, believes Agrawal.

Disclaimer: This story is for educational purposes only. The views and recommendations above are those of individual analysts or broking companies, not Mint. We advise investors to check with certified experts before making any investment decisions.