Stocks continue to be pressured as bond yields in the U.S. hit their highest level in 16 years.
In the U.S. Treasury market, which is the largest and most important bond market in the world, 10-year bond yields have jumped to their highest level since 2007, before the global financial crisis. However, it is not just in the U.S. where bond yields are spiking. In Germany, Europe’s largest economy, bond yields are at their highest level since the 2011 eurozone debt crisis. In Japan, bond yields are now at levels last seen in 2013. The rising bond yields are putting downward pressure on equities and raising alarm bells around the world. U.S. Treasury bonds typically serve as a benchmark for home mortgages and other consumer and business borrowing rates.
Why Bond Yields Are Rising
A bond yield is the return that an investor realizes on a government or corporate bond that they purchase. The yield is basically the interest that an investor gets on the capital they invest to purchase a bond. The price and yield of a bond are inversely related. This means that as the price of a bond goes up, its yield will go down. Vice-versa, as the price of a bond goes down, the yield goes up, which is what’s happening now. Essentially, bond yields are rising rapidly right now because the global market is being flooded with bonds, and prices are declining.
This is happening for a variety of reasons. Since U.S. Federal Reserve Chairman Jerome Powell signaled at the end of September that interest rates are likely to rise further and stay higher for longer than previously expected, traders have been adjusting their outlooks and bets in the bond market. Traders now forecast that the Fed will only cut interest rates to 4.70% in 2024 from the current range of 5.25%-5.50%. Previously, expectations were that the Fed would drop its key interest rate to 4.30% next year.
A Bond Bear Market
Until now, many investors were betting that bond yields would drop as soon as early 2024. They’re now revising those bets and dumping bonds in the process, pushing down prices and lifting yields. At the same time, central banks around the world are in the process of issuing new bonds. The U.S. government, for example, raised a net $1.007 trillion through bond sales in this year’s third quarter, which was the largest-ever bond issuance during a third quarter.
The bottom line is that there’s a lot of bond selling happening right now, which is squashing prices and causing yields to spike. U.S. bond prices are currently 15.6% below their peak seen in the summer of 2020. During the onset of the Covid-19 pandemic, traders and investors rushed into the relative safety of government bonds, driving up prices and pushing down yields. Now, the opposite is happening. We’re in what’s being called a “bond bear market,” and at 38 months and counting, it is the longest such bear market for bonds in market history.
Bad News for Stocks
Complicating matters in the bond market are troubled fiscal outlooks for several economies. In August, Fitch downgraded the United States’ long-term credit rating to AA+ from AAA, citing a government deficit that just reached $33 trillion. Elsewhere, the highly leveraged government in Italy has raised its deficit outlook for the rest of this year. A combination of credit ratings and bond yields determines how much interest governments pay to take out loans and fund their operations. Rising interest costs could destabilize some heavily indebted countries, notably in the developing world.
For stocks, rising bond yields lead to an outflow of capital as investors seek to buy cheap bonds and earn high rates of return on their cash rather than risk money on more unpredictable equities that rise and fall each day during open trading on a stock exchange. The S&P 500 index has now fallen 8% since its July peak this year, a downturn that has coincided with rising bond yields. If yields on bonds continue spiking, as many analysts forecast, stocks can be expected to decline in the near term.
Many analysts expect the yield on the U.S. 10-year Treasury to continue rising and eventually top 5%. Germany’s 10-year bond yield is forecast to reach 3%, up from 0% in 2022. This trend towards higher bond yields is likely to continue pressuring stocks. Until we get a clear sign that interest rates have peaked and are likely to come down, investors should anticipate heightened volatility in equity markets.
On the date of publication, Joel Baglole did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.