Bloomberg Businessweek March 15, 2021 pp24-25|Finance|”The New Market Next Exit” “Investors are struggling to work out what a recovery from the pandemic means” “Bottom Line Stock markets have been roiled by spikes in Treasury yields, which might signal some fundamental changes in the economy”
U.S. 10 Year Treasury Rate from 2016 to now. Chart from macrotrends.net
Chart not in Bloomberg Businessweek article.
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Summary of the Article
Data presented in a chart shows that the Dow Jones Industrial Average Index “which includes traditional businesses sensitive to the economy such as Amercian Express, Caterpillar and Chevron-is up 5.5% this year” while the Nasdaq 100 rose more than 6% but then fell precipitously after February 12 and is now just in negative ground after rising from as low as -3%. The Nasdaq rose with the pandemic as many felt those stocks dominated by Amazon-Apple-Microsoft would perform well with increasing demand for computers, for internet use and for online gaming. The Nasdaq fell as investors began to see them as possibly overpriced or in a bubble from the pandemic run-up. In such times some investors will start purchasing bonds as a hedge against the potential downside in equities.
The U.S. 10 Year treasury bond yields increased sharply in recent weeks as prices for the bonds fell. Confusing? Yes. In an economic recovery, such as we are experiencing, companies are likely to outperform previous downbeaten expectations. For shareholders this equates to anticipating a better that expected return on investment. In such a case, of great corporate returns, bonds with low but stable returns are unattractive. But there’s a limited amount of enthusiasm for stocks as well when investors begin to worry that inflation will set in and lower corporate revenue and profit. Inflation can result if demand rises so sharply as to stress the supply of raw materials and commodities. A viscious cycle starts as producers then have the business need to raise prices as well. As prices increase consumers have less buying power and they reduce consumption. Further complicating matters, is that lending rates rise as well for businesses and consumers cutting deeper into corporate profit and consumer buying.
The Federal Government issues Treasury bonds for the specific purpose of supplying cash to finance existing and new debt. As it is the 10 Year Treasury yield or rate is the benchmark for all debt. It is the lowest rate currently available and forms the basis for all other debt instruments. If the 10 Year rates rises so do the higher-risk-based rates available to companies and consumers.
What drives treasury bond prices? If Treasury bonds aren’t selling then the government, still needing to fund its debt, must make the bonds more attractive by increasing the yield or rate the bonds will pay to buyers. With the appropriate investor demand, in response to new bonds with higher yields, bond prices will be driven up thereby limiting the upward pressure on yields.
If the Federal Reserve and the U.S. Treasury were concerned about the underlying fundamentals of the economy, in this case concerns that the economy was in danger of overheating coming out of the pandemic, then they could move to raise yields even further. Raising rates repeatedly fuels worry about significant inflation. So far, the Federal Reserve (Jerome Powell) and the U.S. Treasury (Janet Yellen), while concerned about some high-flying stocks, have signaled that the economy is still in need of recovery and stimulus. This is reassurance that rates will remain relatively stable. Worthy to note as well that current rates have edged up but are still within nominal levels.
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