Bonds Bite Back

Earlier this morning, stocks were poised to put in a performance that would be similar to yesterday’s, when the S&P 500 (SPX) was almost perfectly unchanged even as tech stocks pulled the Nasdaq 100 (NDX) higher.  A dose of further consolidation or some modest profit-taking seemed to be in order.  Bond traders had other plans, though, and a sharp jump in yields put a damper on equities.

As I type this before noon ET, 2- and 10-year Treasury yields are higher by 10 and 12 basis points, respectively.  That move pushes the 10-year yield firmly through the psychologically important 5% level.  Over the past few days, as those notes tested 5% on three separate occasions, with each successive high in yields very slightly below the prior test, they were able to recover to the 4.92%-4.95% range after each of them.  Today, however, we have blown through those prior high yields, taking us to levels not seen since 2007 – prior to the Global Financial Crisis (GFC). 

10-Year Treasury Yield, 30-day Candles

Source: Bloomberg

The reasons for today’s rise in yields are relatively subtle, though they build on themes that have been in place for some time.  We have a relative dearth of economic reports this week, so we need to dig a bit for a reason behind today’s bond moves.  It is quite possible that the combination of stronger-than-expected PMI reports, higher oil prices, and a lackluster reaction to the news that the next round of Treasury buybacks, scheduled for tomorrow, would be the same as the prior $6 billion is behind the move.  Combine those factors with the prevailing sour mood among global bond markets, and it makes sense that a break above the prior high yields would lead to stop-loss selling (remember, higher bond yields mean lower bond prices).

Interestingly, even though rates have been rising across the yield curve, its shape has nonetheless changed in diverse ways.  The 2-10 spread has collapsed in recent weeks, falling from 54 basis points to 19.6 basis points in just over a month.  Meanwhile, the 3-month/10-year spread is over 95 basis points, near the recent highs of about 1%.  This divergence reflects the persistence of expectations for Fed rate hikes over the coming year.  Just under four hikes are being priced in, which roughly explains the difference between the 3-month and 2-year rates.  Although the inversion in 2- vs. 10-year yields that persisted from mid-2022 through mid-2024 did not presage a recession, as was typical for inversions throughout history (thanks AI!), we need to wonder if (1) the current compression is reflecting concerns about the economy, or (2) some hope that the current FOMC measures is reflecting some optimism about the Fed’s measures to fight inflation, even as rates rise anyway because of liquidity concerns.

1 Year Graph of Yield Spreads: 2/10 Spread (white bars), and 3-month/10-year Spread (blue line)

Source: Bloomberg

Considering the gloomy picture being set by bonds, stocks really aren’t performing all that badly – at least at the major index level.  It is certainly not a good day when only two SPX sectors are higher (energy by more than 1% and industrials up slightly), but the -0.6% and -0.9% moves in SPX and NDX, respectively, are still giving back only a fraction of Monday’s rally and an even smaller fraction of the moves that have occurred since Thursday.   Might this be another example of the “ratchet effect” in action, where good news is handsomely rewarded and bad news is greeted with a relative shrug?  Quite possibly.  The dearth of economic news and earnings reports has stocks focused on geopolitical and internal market narratives, and since stock investors tend to pick and choose which geopolitical issues matter on any given day, it is hard to imagine that equities will truly capitulate before the latest enthusiasm for AI fades.  And with Meta Platforms (META) still up more than 2% on the day, that enthusiasm hasn’t fully faded.