Treasury yields are rising once more on Thursday, with the yield on the
10-year
back above 4.3%, on pace for its highest point since late 2007.
That’s a problem for the stock market, which has already seen its rally fizzle in August: Higher interest rates on virtually risk-free bonds reduce the premium investors can expect from riskier assets such as stocks, making it much less attractive to buy shares. That’s especially true as 2023’s gains have left the
S&P 500’s
valuation relatively high, amid plenty of volatility.
Unfortunately for stocks, there seems little to stop yields from continuing to march higher, particularly as hawkish notes from last month’s Federal Open Market Committee meeting clash with Wall Street expectations that this cycle’s interest-rate hikes are all in the rearview mirror.
Benjamin Jeffery, BMO Capital Markets’ vice president of rates strategy, notes that in terms of the 10-year yields, “the true support level to monitor today is 4.335% that is the cycle high-yield mark from October of last year.”
Of course, there are any number of reasons why Treasury yields should be higher, and they don’t always weigh on stocks. While today’s levels haven’t been seen since the Great Financial Crisis, the past decade and a half have been years of abnormally low interest rates; payouts on the 10-year T-note historically have been above current levels in the period before the crisis.
The problem, as 22V Research’s President and Chief Market Strategist Dennis DeBusschere notes, is that it’s happening for the wrong reasons, as “the story is not that weakening economic growth and increasing Treasury supply are driving long term yields higher.”
Given that the economy and wages have held up, it looks difficult for inflation to fall much further, and that “means increased risk that financial conditions will need to tighten much more,” he writes. In other words, the potential need for higher interest rate hikes, which are troublesome for risk-on asset classes and can push yields higher. Thus, while it might seem contradictory “economic growth needs to slow some for a broad risk-on rally to take hold.”
Likewise, Nicholas Colas, co-founder of DataTrek Research, argues that real rates—which exclude the impact of inflation—also point to yields to go higher.
Unlike in last October, when we previously saw 10-year T-notes topped out in their prior cycle, inflation expectations are no longer falling, instead sticking around 2.3%; in addition, one only has to look back to the pre-crisis period to see when real rates traded between 2% and 2.7%. With real rates (calculated by subtracting the consumer price index from the fed-funds rate) at present approaching 2%, Colas argues we could be headed for a return of that range.
Therefore, he continues to target 10-year yields reaching around 4.5%: “The current slow-motion long-term rate shock has a way to go, in our view, and equity markets will struggle as it evolves. All this fits with our belief that we’re in for a sloppy few weeks ahead.”
So we might be in for a cruel end to the summer.
Write to Teresa Rivas at [email protected]
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