Stocks are declining, government bond yields are surging, and investors are reacting strongly to economic information that they typically overlook. In other words, the markets are jittery, alternating between fears of an overheating economy and concerns about a sharp downturn leading to a recession. This kind of environment makes big economic updates, like the September jobs report, crucial for market movements.
The nervousness is most apparent in the $25 trillion market for U.S. Treasuries, where yields on government bonds have reached levels not seen since 2007. While the increase in bond yields reflects expectations of a strong economy, it has also affected the stock market. Generally, higher yields are considered negative for stock investors, and as a result, the S&P 500 index has been declining for five consecutive weeks.
If the jobs report deviates from economists’ expectations of a 170,000 gain in September, there could be significant market movements.
It’s all about interest rates.
There are different interest rates that matter in the financial landscape. The Federal Reserve sets a target rate for overnight borrowing costs. Consumer and corporate borrowing rates, such as those for credit cards or mortgages, are also significant. Additionally, government debt yields, which take into account inflation and economic growth, play a crucial role in the financial system.
Among these rates, the yield on the 10-year Treasury bond is arguably the most important. It represents the cost for the U.S. government to borrow money from investors for 10 years and influences other long-term interest rates worldwide. It also impacts how companies are valued, making it influential in the stock market. Higher treasury yields indicate increased costs for consumers and businesses, which usually weighs on the market.
This week, the yield on the 10-year Treasury bond rose to its highest level in 16 years, reaching 4.8 percent from 4.57 percent. As a result, the S&P 500 has declined 1.6 percent this week and approximately 7 percent over the past two months when the yield started rising.
Rates have been rising for a while. What’s so scary now?
The Federal Reserve has been raising interest rates for about 18 months. However, the yield on 10-year Treasuries remained relatively steady for the first half of 2023, ranging between 3.5 and 4 percent.
During this period, the S&P 500 experienced a significant rally, fueled by better-than-expected corporate profits, slowing inflation, a resilient economy, and a growing consensus about the end of the Fed’s rate-raising cycle.
Yet, persistently strong economic data has increased expectations for growth, while concerns about stubbornly high inflation have raised the possibility of prolonged elevated rates. In early August, the yield on the 10-year bond began to climb rapidly.
This movement has disrupted some long-held assumptions in the market. Investors are now reassessing the implications of higher rates for consumers and businesses, leading to a sell-off in stocks. September witnessed a slump of nearly 5 percent in the S&P 500, marking the worst month of the year so far.
Combined with a significantly appreciating dollar, linked to rising interest rates, and volatile changes in oil prices, the economic outlook has become more uncertain.
“All these things thrown into a blender — the uncertainty and the speed of how things are moving — is what has kept the market uneasy,” said George Goncalves, head of U.S. macro strategy at MUFG Securities.
Is congressional turmoil a factor?
The recent events of a potential government shutdown and the removal of Kevin McCarthy as House speaker did not solely rattle the markets. However, they shed light on the government’s instability, coming just months after narrowly avoiding a damaging debt default.
Rising interest rates have compounded concerns about the government’s finances. High rates draw attention to the increasing costs of servicing the United States’ massive debt and persistent budget deficits.
If economic growth slows, the fiscal challenge facing Washington will intensify, according to Ajay Rajadhyaksha, global chairman of research at Barclays.
Assuming no spending cuts and sustained elevated rates, higher deficits could lead to increased yields, thus creating a cycle of growing deficits.
