Soaring U.S. Yields Spook the Stock Market Rally

Anxiety among investors is being fuelled by the sharp rise in bond yields, driven by indicators of stronger-than-anticipated growth in segments of the global economy. This has prompted speculation that central banks may keep interest rate levels elevated for longer. The U.S. 10-year Treasury yields reached their highest level in 15 years on Monday, and U.S. real yields, which reflect returns on government bonds after factoring in inflation are near their 2009 peak.

Soaring U.S. Treasury yields are sending ripples of unease through higher-risk market segments, leaving market participants speculating on the extent to which this could dent the stock market rally. Heightened economic growth prospects have reinforced expectations that the U.S. Federal Reserve will sustain higher rates for an extended period, propelling Treasury yields to levels not witnessed since 2007.

The surge in energy prices is also raising concerns that the inflationary impact on the global economy is not yet abated, despite some cooling in price pressures. European gas prices have surged significantly, and oil prices are near nine-month highs, following output cuts from Saudi Arabia. These movements in energy markets, which are pivotal drivers of inflation and inflation expectations, suggest that despite price pressures cooling the fight against inflation is not done yet. Consequently, the narrative around interest rates remaining higher for a longer period than initially anticipated has gained traction in recent times.

In addition to these factors, China’s property sector is undergoing an unprecedented debt crisis, alongside a string of disappointing economic data in the world’s second-largest economy. This is raising fears that further problems could spill over into global markets. The property sector contributes approximately 25% to China’s economy and adds to the existing challenges, such as sluggish domestic consumption, weakening industrial activity, rising unemployment, and weak overseas demand.

The financial sector has not remained unscathed, as S&P Global Ratings downgraded on Monday five regional U.S. banks by one notch and signalled a negative outlook for several others. Moody’s had undertaken similar downgrades two weeks ago and is reassessing the credit ratings of larger banks.

Source: TradingView, S&P 500 Yearly Chart

The S&P 500 has dropped 6% this month, as the U.S. benchmark 10-year Treasury yield surged to 4.36% – its highest level in over 15 years. A crucial test for market sentiment is the annual gathering of central bankers in Jackson Hole, Wyoming, on Friday where Federal Reserve Chair Jerome Powell is scheduled to deliver an address on the economic outlook.

Some investors believe that equities will maintain their resilience in a year where the benchmark index has had an impressive run and gained 15% year-to-date. Prospects of a soft landing for the U.S. economy further support this sentiment, with predictions that the recent reduction in equity exposure will be short-lived. Company earnings may have reached their nadir in the second quarter and are likely to expand in the third quarter, potentially propelling the index to new highs by year end.

However, other investors are concerned that various destabilizing factors are beginning to emerge, impacting sentiment and risk appetite. These include surging bond yields, rising energy prices, and mounting concerns about China’s economic slowdown. These developments are causing investors to reevaluate their positions following a period of sustained stock market gains.

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