10-year Treasury yields reached their highest point all year on Tuesday, sending stocks to the gutter for the second straight day following the release of economic data hinting that the Fed may not cut rates so soon.
Treasury yields and stocks typically operate in opposition with one another — as one rises, the other typically falls — as investors’ risk tolerance changes. However, according to some analysts, the recent rise in bond yields doesn’t actually represent a meaningful threat to equities, at least right now.
As the 10-year yield rose to 4.4% Tuesday, there seemed to be a natural “flight-to-safety” movement from relatively high-risk stocks to the slow and steady fixed-income market. Reasonably so, the S&P 500 slid nearly 0.8%, while the Nasdaq Composite fell 0.93%.
The question is: Why?
Well, red-hot jobs and production data released last week suggests inflation may not ease so quickly. Job openings actually increased in February, while U.S. manufacturing activity grew at its fastest pace since 2022.
In short, investors sold stocks because the economy has been actually doing a bit too well, hurting the chance of inflation falling and, thus, the chance of a near-term rate cut.
Evercore ISI Vice Chair Krishna Guha, however, believes the data doesn’t necessarily change the disinflation timeline:
“In these conditions, absent an insane boom, indicators of tightness matter more for the rates outlook than indicators of strength. These indicators, including today’s JOLTS, are thus far showing no signs of renewed tightening. As long as that remains the case, strong activity — and strong payrolls — do not represent a threat to the inflation outlook.”
This is a notable point. Why would evidence of a strong, resilient economy cause investors to make the flight-to-safety trade?
Answer: It doesn’t.
Treasury Yields Don’t Tell the Full Story
One could argue that this year’s rally has been based on the notion that rate cuts are just around the corner. Indeed, heading into the new year, Federal Reserve Chair Powell shocked onlookers why openly conceding that the central bank will cut rates three to four times in 2024.
This late into the game, however, with inflation nearly at Fed-acceptable levels, it’s surprising that investors read so heavily into strong economic data to the point of selling stocks, presuming inflation will somehow return to its elevated prior levels and rates will never come down.
The central bank has echoed a similar sentiment.
“In and of itself, strong job growth is not a reason, you know, for us to be concerned about inflation,” Powell said at the last press conference.
This time around, Treasury yields do more to point out the contradiction in the minds of many investors than reflect some sort of hidden inflationary mechanism likely to poke its head out in the coming months.
High Rates But a Still Expanding Economy
No one likes high rates, but mostly because it hurts economic expansion. Yet, the economy is expanding quite well. Businesses are hiring. Inflation is a fraction of 2022’s peak.
While Treasuries have historically operated as a sort of fortune teller, this time around, it simply doesn’t reflect the state of affairs in the economy or in the stock market.
“Because potential output is growing more than usual due to strong labor supply and healthy productivity, the speed limit for non-inflationary growth is higher than normal,” Guha noted. “In these conditions, absent an insane boom, indicators of tightness matter more for the rates outlook than indicators of strength.”
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
