The stock markets are slipping, government bond yields are rising rapidly and investors are reacting strongly to increasing economic information and sifting through it for the slightest clues about the way forward.
This investor sensitivity has made markets nervous – swinging between fears that the economy is running too hot and worries of a downturn so severe that it will plunge the country into recession.
The squeamishness is most evident in the $25 trillion U.S. Treasury market, where Treasury yields have risen to their highest level since 2007. Although the rise in bond yields partly reflects bets on a strong economy, the moves have extended to the U.S. stock market as well. For stock investors, higher returns are generally a negative – and the S&P 500 index is on track for its fifth straight weekly decline.
After the government reported on Friday that employers added 336,000 new jobs in September, significantly more than economists expected, stock futures, which allow investors to bet on the market before the official start of trading, and yields fell Government bonds rose to 16 years.
It’s about interest rates.
There are many different interest rates that are important. There is the interest rate that the Federal Reserve sets and which serves as the target for the overnight cost of funds. There are interest rates for consumer and business loans, such as credit cards and mortgages. And then there are Treasury yields, which partially follow the Fed’s key interest rate, but span much longer periods of time and take into account other information such as inflation and economic growth.
Arguably the most important of these interest rates is the yield on the 10-year Treasury note, a measure of what it would cost the U.S. government to borrow money from investors for 10 years, but also a determining factor for virtually all other long-term interest rates of the world is therefore a cornerstone of the global financial system.
It also influences the valuation of companies and therefore has an impact on the stock market. Higher Treasury yields indicate higher costs for consumers and businesses, which typically weigh on the market.
This week, the yield on the 10-year Treasury note rose to over 4.80 percent from 4.57 percent at the end of last week, its highest level since 2007. After peaking in the days leading up to the release of the jobs data, the yield rose Friday’s report quickly returned to over 4.8 percent. S&P 500 futures pointed to further decline, resulting in a weekly loss of 1.6 percent. The S&P 500 has fallen about 7 percent in the more than two months that yields have risen.
Interest rates have been rising for some time. What’s so scary now?
The Fed has been raising interest rates for about 18 months, but the 10-year Treasury yield had remained fairly stable in the first half of 2023, hovering in a range of 3.5 percent to 4 percent.
During that period, the S&P 500 rose nearly 20 percent, buoyed by better-than-expected corporate earnings, slowing inflation, a robust economy and greater consensus about the end of the Fed’s rate-hiking cycle.
But continued strong economic data has led to higher growth expectations, while worries that inflation could remain stubbornly too high have raised expectations that the Fed may need to keep interest rates high for longer than previously thought to complete the job of containing prices. As a result, the 10-year bond yield began to rise rapidly in early August.
This move has upended some of the market’s long-held assumptions. After a period of relative stability, investors are reassessing what higher interest rates could mean for consumers and businesses, triggering a selloff in the stock market. The S&P 500 fell nearly 5 percent in September, its worst month of the year so far.
Add to that a sharply appreciating dollar – also coupled with rising interest rates – and wild swings in oil prices, and the outlook for the economy has become more uncertain.
“All of these things thrown into a blender — the uncertainty and the speed at which things are moving — has worried the market,” said George Goncalves, head of U.S. macro strategy at MUFG Securities.
Is unrest in Congress a factor?
The recent bout with a government shutdown and the ouster of Kevin McCarthy as House Speaker on Tuesday did not alone rattle markets but highlighted the government’s instability just months after it narrowly averted a potentially devastating debt default.
Rising interest rates have heightened concerns about the government’s finances, with the prospect of high interest rates drawing attention to the rising costs of servicing the United States’ vast mountain of debt and persistent budget deficits.
Unemployment is currently low and the economy is developing better than many expected. If growth slows, Washington’s fiscal challenge will worsen, said Ajay Rajadhyaksha, global head of research at Barclays.
And assuming there are no spending cuts and interest rates remain high, higher deficits could lead to higher returns, Mr. Goncalves said, which in turn could drive deficits higher.