Why is everyone talking about bond yields?

Bond yields are the talk of the town, slated as a potential factor that could drive a sharp correction across global equity markets. 

Overnight, US 2-year Treasury yields - which reflect short-term interest rate expectations - rallied above 1% for the first time since February 2020.

The 2-year has 5-fold since September last year.

In the past, the 2-year has closely tracked benchmark US interest rates.

The recent divergence suggests that interest rates have a lot of catching up to do. 

US 2-year Treasury yield vs. US benchmark interest rates, TradingView

The US Federal Reserve has penciled in a plan to hike interest rates to 2.1% by the end of 2023.

The general consensus is that the Fed will raise interest rates three to four times this year.

Assuming 25 basis point hikes, this would bring interest rates back to parity with the 2-year.

A new chapter

The hawkish pivot will mark a new era of expansionary monetary policy after a prolonged era of near-zero interest rates.

As Charlie Bilello from Compound Capital points out, there is an entire generation of new investors that have never experienced an interest rate hike and conditioned to believe that every dip is buyable.

Over in the US, the S&P 500 (large caps) is in the midst of its 25th dip (of more than 5%) since March 2009. Every single dip was met with a recovery to new highs.

Source: Charlie Bilello, Compound Capital

The looming interest rate environment has already proven to be challenging for high price-to-earnings (P/E) stocks that rely on future earnings to justify present valuations.

The S&P/ASX 200 Info Tech Index is already down -13% year-to-date, weighed by a sharp decline in Afterpay (ASX: APT) shares.

The broader ASX 200 has remained relatively unscathed, given its weighing towards banks and miners, down just -2.75% year-to-date

Indeed the market has rewarded brave dip buyers.

But what happens when market dips on a rising interest rate playing field?

Will it sink or swim?