Bond prices collapsed for the third consecutive day on Monday, sending yields sharply higher, with the 10-year yield trying to breach above the psychological level of 1.5%.
From August 2020 until March 2021, the yield on the 10-Year Treasury rose rapidly as inflation entered the US financial system and the economy. Inflation is the biggest enemy of bonds – imagine you hold a 10-year bond with a 1.5% fixed coupon, paid yearly. At the same time, inflation jumps to 3% yearly. You lose 1.5% in real money each year while holding the bond. Not a good investment choice.
Since March 2021, bond yields have been moving lower, and it looked like the recent bull run is over. But everything changed in September, when the 10-year yield moved back above its 50-day moving average, indicating another leg higher is to be expected. It came a couple of days ago.
As Nomura’s Charlie McEligott noted this morning, real yields have been marching higher recently. It continues to look more like the overall rates selloff has been a risk-premium trade – thanks to recent Federal Reserve (Fed) policy updates with guidance faster tapering and more hikes in the dot plot – as opposed to a view on heightened or accelerating growth- or inflation expectations. Particularly with the latter going nowhere but sideways since the start of June.
Rising rates are generally bad for growth and technology stocks. The Nasdaq 100 index was down more than 1% Monday, suggesting a much deeper correction could occur if yields continue to rise higher.
If the Fed tightens monetary policy more aggressively than expected, it will most likely crash stocks.
If the Fed doesn’t act now, inflation will rage further, leading to a stagflationary collapse in the economy and equities could still crash as inflation destroys profits in the corporate sector.
The Fed is indeed trapped. But for now, let’s watch US yields to tell us where the stock market might be heading in the nearest future.