On a Thursday in late February, stocks took a tumble from their lofty perch. The Dow Jones Industrial Average lost 1.8%, the S&P 500 went down 2.5%, and the Nasdaq Composite dropped 3.5%.These numbers represent the worst days for these stock indexes in weeks or even months in the Nasdaq’s case. What happened? Bond yields spiked. Interestingly, it happened a month later–this time it was because Fed Chief Jerome Powell didn’t address the “rate shock” as aggressively.
The stock market has been a bit of a rollercoaster lately but, overall, it has been a very good investment for many people in the last few years. As anyone who was invested during the financial crisis of 2008 knows, that can change at a moment’s notice.
While most expert investors aren’t yet incredibly worried, the bond yield spike in late February is giving investors pause. The relationship between the stock market and higher bond yields is a tenuous one right now and these yields could mean bad things for your stocks. Here’s what you need to know about why higher bond yields can cause the market to crash.
What are 10-year Treasury bonds?
10-year Treasury bonds (or notes) are government-issued bonds that come to maturity in 10-years and pay out interest every six months. When interest rates rise, which happens when the Federal Reserve wants to fight inflation, Treasury bonds become a good, safe investment.
What does bond yield say about inflation?
The short answer is, nothing necessarily. Bond yield and inflation aren’t directly tied. However, a spike in the 10-year Treasury yield, like happened in late February, does show that investors may be worried about inflation down the road.
In just two weeks, the 10-year yield jumped from 1.13% to a high of 1.61%. The yield has not been this high since the pandemic was about to start in February of 2020. What this means is that, although the Federal Reserve Chairman, Jerome Powell, has said that inflation is not coming and that interest rates will not be rising soon, some investors aren’t so sure.
What does higher bond yield mean for the stock market?
Again, there is no direct causal relationship between inflation, rising interest rates, and the stock market but you can start to read the signs when you see the bond yield spike like this. Right now, the stock prices are booming, especially in the tech sector. If inflation and interest rates stay low, this should continue to be the case.
What the higher 10-year yield says though is that many investors expect inflation and rates to go up. This is what led investors to jump ship on previously high-performing stocks in late February. The bond yield spike signaled that investors may soon need to look for safer investment alternatives which made stocks – especially tech stocks that are notoriously risky and that benefit from low-interest rates for borrowing – drop fast.
What can the Fed do to protect the stock market?
The day the 10-year yield spiked, it did eventually end up settling down a bit. The yield closed the day at 1.51% and has settled into the 1.4% range in early March. This should be a sign to both investors and the Federal Reserve though of how quickly inflation can crash our current sky-high stock market.
The Fed can help keep the stock market cruising along by keeping short-term yields low as they are currently doing and as Powell says they will stay committed to. As long as the Fed doesn’t have to hike rates and yields quickly to deal with spiking inflation, the stock market should be ok. If the short-term yields jump like the long-term yields did in February, the stock market may be in trouble.
Please be aware that the content of this blog is based upon the opinions and research of GFF Brokers and its staff and should not be treated as trade recommendations. There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.