Will the surge in Treasury yields slay the bulls (again)?

Matt Terrien, of Taiko, and Michael Rosen, of Angeles Investments

So far in 2024 the rise in the 10-year Treasury yield has not significantly impinged on the market’s bullish behavior.

The yield on the benchmark 10-year Treasury Note is causing market-watchers to, well, yield and take notice.

Last fall there was a fairly strong inverse relationship between stocks and the 10-year Treasury yield, with the S&P 500 selling off as the 10-year Treasury climbed toward the 5 percent level.

That link eased somewhat with the arrival of a new year, and so far in 2024 the rise in the 10-year Treasury yield has not significantly impinged on the market’s bullish behavior. The 10-year Treasury yield started the year at 3.95 percent and was seen around 4.7 percent at last check, a 19 percent jump in less than four months.

Meanwhile, the S&P 500 closed the first quarter up 10 percent, and still stands 5 percent higher for the year.

The most recent spike in yields (or selloff in bonds since price and yield move in opposite directions) appears to be pressuring stocks once again (Magnificent 7 earnings notwithstanding), or at least unnerving the bulls.

All this begs the question as to whether the inverse relationship between the 10-year Treasury yield and S&P 500 is back. And if so, how tight is the correlation?

In the opinion of Michael Rosen, chief investment officer at Angeles Investments, the 10-year yield is moving higher because the inverted slope of the Treasury curve “makes no sense.”

“Inflation is not falling to target, the economy is humming and the Fed is not easing policy anytime soon. So long-term yields need to rise to reflect this,” said Rosen. “This inverted curve has been the single biggest error in the markets for the past two years.”

As a result, Rosen recommends bond investors remain short duration. As for equities, he expects the impact of the rising 10-year yield to be modest.

“Profits drive equities, not interest rates, and as long as profits remain strong, equities will perform well,” said Rosen, adding that corporations are “less interest-rate sensitive than in the past, due to robust profits and balance sheet deleveraging, so a modest rise in rates will have minimal effect.”

Meanwhile, Matt Terrien, director of research at Taiko, an OCIO for RIAs, says sticky inflation and strong labor market data have pushed out the timeline for anticipated interest rate cuts by the Federal Reserve. That being the case, he believes interest rates could continue to drift higher.

“Although we do not have a precise level in mind, we think it’s reasonable to assume the 10-year Treasury yield could approach the 5 percent level as market participants realize the Fed is unlikely to cut rates anytime soon,” said Terrien. “We have discussed the possibility of extending the duration of clients’ fixed income portfolios but remain neutral as we believe it would be premature to call a top in yields currently.”

As for the step-up in yields impact on stocks, Terrien notes that the effects of the Fed’s rate hikes over the last year and a half are still becoming manifested in the economy and the economic surprises have been to the upside.

“The Fed has every reason to hold steady and persist with the higher for longer’ mantra, suggesting the much-watched 10-Year Treasury yield could test its resistance in the 4.8 to 5 percent range,” said Terrien.

Meanwhile, Joyce Huang, senior client portfolio manager at American Century Investments, says she was surprised when the yield on the 10-year yields declined so much at the end of 2023. And in her view, not much has changed since then.

“I think the market just got really ahead of itself at the end of last year and we had over-exuberance,” said Huang. “The market was pricing in seven Fed cuts at that point. In our minds, that was totally unrealistic.”

She views the recent back up in rates as sensible yet doesn’t see much follow through ahead.

“We’re not in the 5 percent 10-year camp. We do think this is likely the peak,” said Huang.

Finally, Steve Sosnick, chief strategist at Interactive Brokers, attributes the rise in rates largely due to the strong performance of the economy. And that’s okay for him in terms of the stock market’s push higher.

That said, if the economy “moves sideways with a possible return of inflation” then he fears more Americans will start speaking about stagflation, which in his view would be a more serious problem for both the economy and the stock market.

“But as of now, we can ignore it because the rise in rates is predicated on good economic numbers,” said Sosnick.