Bond Market Roller Coaster – Should We Be Worried?
The Treasury markets have sure been on a wild ride. With 10-year Treasury rates hovering between 0.5% and 1.0% for the past year, rates have begun to surge. The 10 Year breached 1.5% today for the first time since Covid cases began to rise in early 2020.
As longer-dated bonds sold off and the yield curve steepened, the stock market got spooked and sold off quickly and US indexes closely down sharply. Even with a Fed that continued to speak with a dovish tone, recent bond market action is suggesting that inflation will rise more later this year. Most likely, when the economy opens and another massive stimulus package potentially floods the economy with $trillions more of spending.
Another catalyst to today’s stock selloff is the new parity between the S&P’s stock dividend yield of 1.51%, versus the risk-free rate of 1.52% on the 10-year Treasuries. One factor that contributed to the jump in stock prices over the past several months was the search for yield. Investors weren’t getting paid enough from historic-low yields in Treasuries and they began seeking out riskier assets (stock) in search of yield. Now that Treasury yields are rising to levels at or above that of the stock market, investors have less motivation to take on the risk of buying or holding stocks to receive the same yield they can get in Treasuries.
As last quarter’s earnings season comes to a close the majority of earnings have surprised to the upside. Once life gets back to normal and the economy fully reopens, we should see more earnings reflect the pent-up demand that’s been waiting to be unleashed. If history repeats itself, volatility will calm down and earnings growth should continue, even in spite of slightly higher interest rates. In the meantime, I wouldn’t be too surprised if this bumpy ride continues a while longer.