US bond yields continue to move higher, and stocks aren’t liking it one little bit.
From September last year, the yield on benchmark 10-year Treasury notes has risen more than 60 basis points, hitting a high of 2.73% on Tuesday, a level not seen since early 2014.
After ignoring the move in the early parts of January, the continued lift in yields has now caught the attention of stock market investors.
US stocks, after falling heavily to start the week, extended those losses on Tuesday, culminating in a 1.37% slide in the Dow Jones Industrial Average, the largest one-day percentage decline since the UK Brexit vote in mid-2016.
While the lift in bond yields was not the only thing contributing to the selloff, it’s clear that it was a major factor.
Suddenly, rather than being indicative of a stronger global economy, higher yields are being seen as a headwind for economic growth and corporate earnings, contributing to recent bout of profit-taking in stocks.
But are 10-year note yields around 2.7% a true headwind for economic activity and earnings?
According to Matthew Luzzetti and Justin Weidner, economists at Deutsche Bank, even with the recent lift in yields they’re not even close to being restrictive on the US economy and earnings.
“Our updated estimates… confirm that there is considerable further scope for bond yields to rise before they weigh on growth and equities,” they say.
“Currently, the neutral 10-year yield in nominal terms is nearly 3.5% — its highest level since Q3 2016 — suggesting that bond yields could rise about 80 basis points from current levels before we would begin to worry about them slowing growth momentum.”
And, based on historic relationships, Luzzetti and Weidner suggest yields are still a long way off becoming a headwind for US stocks.
“As long as the 10-year yield is below the nominal 10-year-star (the level where yields are neutral, neither supporting or restricting growth), the correlation between equities and bond yields has typically been positive,” they say, referring to the relationship where bond yields and stocks both tend to rise and fall simultaneously.
“Conversely, if the 10-year yield is above the nominal 10-year-star, further increases in yields typically coincide with lower equity values.”
With the 10-year nominal note yields currently sitting just above 2.7%, Luzzetti and Weidner say yields need to lift by a further 80 basis points to hit levels that have typically led to weakness in stocks.
“Despite the recent bond market selloff, Treasury yields have significant scope to rise further before they begin to weigh on the economy or roil equity market,” they say.
While no one knows whether the recent selloff in stock will last, if Deutsche Bank is on the money and history is a guide, the recent weakness may not last.