Key Takeaways
- Treasury yields rose above 4.1% for the first time since July this week, extending a run-up that’s paradoxically coincided with the beginning of a rate-cutting cycle by the Federal Reserve.
- The strength of the economy and an expected rebound in corporate earnings could insulate the stock market from headwinds of rising yields.
- Some experts say it’s unlikely yields will climb much higher than they already have considering inflation’s sustained moderation and labor market cooling.
The yield on 10-year Treasurys crossed 4.1% for the first time since July this week, extending an ascent that has paradoxically coincided with the beginning of a rate-cutting cycle.
The yield on the 10-year Treasury has risen by about half a percentage point since dipping below 3.6% on Sept. 17, the day before the Federal Reserve lowered its benchmark federal funds rate from its highest level in more than 20 years.
Stock investors are often unnerved by rising yields for a few reasons. First, they draw money away from the stock market and lower stock valuations by increasing the yield on lower-risk fixed-income securities. Second, they discourage consumer and business borrowing, weighing on economic growth and corporate profits in the process.
Why Higher Yields Aren’t Weighing on Stocks
Yet rising Treasury yields haven’t stood in the way of stocks in recent weeks. The S&P 500 on Friday closed at its 45th record high of the year as the 10-year yield was at a two-month high. Major stock indexes have posted gains in five consecutive weeks.
Stocks have been supported lately by growing conviction on Wall Street that the U.S. economy’s strength can support corporate profits. Earnings have mostly held up through years of elevated interest rates, and the Fed’s easing cycle—whether aggressive or more measured—should mostly be a tailwind for business and stocks.
Bank of America analysts expect S&P 500 earnings to grow 15% next year. They also forecast growth will continue to broaden beyond the Magnificent Seven—Apple (AAPL), Microsoft (MSFT), Nvidia (NVDA), Alphabet (GOOG; GOOGL), Amazon (AMZN), Meta (META), and Tesla (TSLA)—which accounted for an outsized share of the index’s earnings growth and market performance in 2023. The “Other 493,” the earnings of which were declining or stagnant throughout 2023 and early 2024, are expected to record double-digit earnings growth in each of the next five quarters.
According to one study from British asset manager Schroders, rising yields compressed stock valuations in 6 of the 11 periods between 1970 and 2021 that they characterize as “rising yield environments.” And yet stocks advanced in all but two of those periods because earnings grew fast enough to offset lower valuations.
Yields Unlikely To Rise Much Further
Few experts expect the 10-year yield to rise much further than it already has, another reason yields are unlikely to derail the bull market.
“The US economy is healthy & unlikely to see recession near term but it also doesn’t appear to be meaningfully re-accelerating,” wrote Bank of America analysts in a recent note. They expect the Fed to continue cutting rates next year, and forecast the 10-year yield will sit around 3.75% at the end of both 2024 and 2025.
Lawrence Gillum, Chief Fixed Income Strategist at LPL Financial, sees a little more room for rates to tick up but still expects yields to fluctuate within a 3.75-4.25% range throughout the rest of the year.
Why Are Yields Rising as Interest Rates Fall?
The surprising strength of the U.S. economy is a key reason for the peculiar divergence between interest rates and yields. The unemployment rate declined in September when the U.S. added far more jobs than expected, according to data from the Labor Department released last week. And inflation ran slightly hot in September, according to data released Thursday.
That’s led Wall Street to doubt the Fed will need to continue aggressively cutting rates to prevent an economic crisis. Last month, the prevailing view among market participants was that the Fed would lower rates by another 75 basis points (0.75%) before the end of the year. Now, the market sees no chance the Fed will move that quickly, according to fed fund futures trading data.
As the outlook for interest rates has changed, so has the market price of Treasurys and, subsequently, their yields, which move in the opposite direction of prices. When investors think that interest rates are going to be lower in the future than they are now, that increases the price—and decreases the yield—of Treasurys trading on the secondary market because they’re expected to pay a higher coupon than future debt. The opposite happens when investors think interest rates will be higher in the future, and the strength of recent labor market data has convinced Wall Street of that.