Investors are now paying close attention to rates
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If rising interest rates are stock market kryptonite, investors are confronting a big chunk of that otherworldly mineral right now.
The big picture: The yield on the 10-year Treasury note, seen as the most important interest rate in the world, has hit its highest level — 5.04% — since 2007.
- This means that the price of money has gone up for everyone from the middle-class homebuyer to the behemoth corporation.
Zoom out: In the past, higher rates on government bonds, or yields, have often meant lower stock prices. There are a few theories why:
- Higher borrowing costs for corporations can slow economic growth and eat into profits, thus making stocks less attractive investments.
- It also makes riskier investments like stocks less alluring relative to higher-yielding and safer Treasury securities.
- Higher rates are also a key input for the discounted cash flow formulas used by finance and investment professionals to calculate what stocks should be worth. (TL;DR: When rates rise, all else equal, the stock values produced by these formulas go down.)
The intrigue: So far, there hasn't been too much of an adjustment from the stock market to the spike in bond yields.
- The S&P 500 is still up 10.8% for the year as of Tuesday's close and not far off the all-time high it touched just over a month ago.
Yes, but: If you listen carefully, you'll hear the uncomfortable murmuring of investors, as they eyeball rising rates alongside portfolios often heavily weighted to equities.
Case in point: Results of a new Bank of America survey of stock market fund managers showed that they see a "disorderly rise in bond yields" as the biggest "tail risk" to the market in September, replacing worries about an AI bubble.
- And the net share of respondents who expect short-term rates to go up is now higher than it was back in 2022, when the post-COVID inflation was starting to rage.
- U.S. equities market analysts at Goldman Sachs noted that "our recent conversations with both corporate executives and portfolio managers have focused on the impact of higher rates on equities."
- Likewise, JPMorgan equity analysts wrote in a note Tuesday that "investors are nervous with respect to inflation and bond yield moves."
The bottom line: After years when the AI trade seemed to be the only thing investors cared about, bonds are making a play for attention.
What to watch: American household portfolios are packed to the gills with stocks, which could make a downturn a painful event.
- Stocks accounted for a record 48% of U.S. household financial assets in the second quarter, according to the Federal Reserve.
- That's roughly 10 percentage points above the high-water mark set during the peak of the dot-com tech boom in early 2000.
What's next: The big event, of course, is the Federal Reserve's rate decision later Wednesday and chairman Kevin Warsh's news conference.
- While the market is almost certain that the central bank will raise interest rates by a quarter point, a more important question for investors will be how much further they will go from here.
- That's not completely under the control of the Fed.
- "If we do have higher and higher oil prices, or let's say a longer and longer conflict," Ralph Axel, interest rate strategist at Bank of America, tells Axios, "central banks will hike more and more."
