|Rowland Goddard, Staff Writer|
The last week of February saw stock market monthly gains depleted by the rise of treasury bond yields. A sell-off in tech shares caused the Nasdaq index to fall 4.9% for the week; its worst weekly performance since October. Similar results were seen in the other major indices. There is a growing concern that treasury yields will continue to rise in March which will cause further damage to equity investors.
Treasury yields are the return on investment of government bonds. Unlike stocks, this investment holds very little risk. This is due to the certainty that the U.S. government will meet its debt obligations. When an investor purchases a treasury/government bond, they have to consider a few characteristics of the bond – most importantly, the maturity date and the federal funds interest rate. A longer maturity, for example a 10-year note, will produce a higher yield. Higher interest rates will cause bond prices to fall.
Many investors see treasury bonds as unattractive, however they do have important implications on the market. Higher yields on long-term treasuries usually indicates a greater confidence in the economic outlook from investors. However, long-term yields can also be a sign of rising inflation in the future. The rise in bond yields also raises the cost of capital for companies, thereby decreasing their stock valuations.
Last week saw the largest monthly surge in 10-year note (bond) treasury yields since 2016. On Monday, February 22nd yields sat at 1.37% and by Thursday, February 25th yields rose to 1.61%. A similar trend was seen in shorter-dated bonds. The five year rose 0.799% on Thursday, its largest one day gain since December 2010. This was largely the result of a positive job data and the fear of growing inflation.
If inflation climbs too quickly, the central bank will be forced to raise interest rates. As mentioned prior, this will result in lower bond prices. As bond prices fall, they become more appealing to investors, causing investment in equities to slow.
Some investors may see this as a good opportunity to “buy at the dip,” as both equities and bond prices are low. However, if treasury yields continue to rise, investors will face more losses. Potentially, the Feds could wait for 10-year yields to hit 2% before intervening and raising the interest rate.
The beneficiaries of the recent movement in the markets are the banks. This is because banks make income from borrowing for shorter periods and lending for longer, earning profit on the spread.
It will be crucial to watch the treasury yields throughout March as the markets decide how they will react to the growing concern of rising inflation. If the yields continue to rise, it will become increasingly difficult for corporations to borrow money to spend on projects, thereby slowing returns on equities.