The Atlanta Journal-Constitution

Here’s why rising Treasury yields are unsettling Wall Street

Economic optimism, fears of inflation have investors scrambling.

- By Stan Choe and Alex Veiga

Yes, it’s possible to have too much of a good thing, and that’s exactly why stock markets around the world are getting so unsettled.

Optimism for an economic revival is surging following a year of coronaviru­s-induced misery. But expectatio­ns for stronger growth — plus the higher inflation that could accompany it — are pushing interest rates higher, which is forcing investors to reexamine how they value stocks, bonds and every other investment.

When it tries to figure out the value for anything from Apple’s stock to a junk bond, the financial world starts by comparing it against a U.S. Treasury bond, which is what the government uses to borrow money. For years, yields have been ultralow for Treasurys, meaning investors earned very little in interest for owning them. That in turn helped make stocks and other investment­s more attractive, driving up their prices. But when Treasury yields rise, so does the downward pressure on prices for other investment­s.

All eyes have been on the yield of the 10-year Treasury note, which climbed above 1.50% last month after starting the year around 0.90%. Here’s a look at why that move shook up the financial world, including the worst week for the Nasdaq composite since October:

Why are Treasury yields rising?

Part of it is rising expectatio­ns for inflation, perhaps the worst enemy of a bond investor. Inflation means future payments from bonds won’t buy as many bananas, minutes’ worth of college tuition or whatever else is rising in price. So bond prices tend to fall when inflation expectatio­ns are rising, which in turn pushes up their yields.

Treasury yields also often track

with expectatio­ns for the economy’s strength, which are on the rise. When the economy is healthy, investors feel less need to own Trea- surys, considered to be the safest possible investment.

Why do falling bond prices mean rising yields?

Say I bought a bond for $100 that pays 1% in interest, but I’m worried about rising inflation and don’t want to be stuck with it. I sell it to you for $90. You’re getting more than a 1% return on your investment, because the regular payouts coming from the bond will still be the same amount as when I owned it.

Why are inflation and growth expectatio­ns rising?

Coronaviru­s vaccines will hopefully get economies humming this year, as people feel comfortabl­e returning to shops, businesses reopen and workers get jobs again. The Internatio­nal Monetary

Fund expects the global economy to grow 5.5% this year following last year’s 3.5% plunge.

A stronger economy often coincides with higher inflation, though it’s been gener- ally trending downward for decades. Congress is also close to pumping an addi- tional $1.9 trillion into the U.S. economy, which could further boost growth and inflation.

Why do rates affect stock prices?

When trying to figure out what a stock’s price should be, investors often look at two things: how much cash the company will generate and how much to pay for each $1 of that cash. When interest rates are low and bonds are paying little, investors are willing to pay more for that second part. Consider a stock like Apple or another Big Tech company, which will likely keep generating large amounts of cash many years into the future. It’s more worthwhile to wait a long time for that if a 10-year Treasury is paying less in the meantime.

And now that rates are rising?

The recent rise in yields is forcing investors to pare back how much they’re willing to spend on each $1 of future company earnings. Stocks with the highest prices relative to earnings are getting hit hard, as are stocks that have been bid up for their expected profits far in the future.

Big Tech stocks are in both those camps. Dividend-paying stocks also get hurt because investors looking for income can now turn instead to bonds, which are safer investment­s. The ultimate worry is that inflation will take off at some point, sending rates much higher.

Aren’t interest rates still really low?

Yes, even at 1.50%, the 10-year Treasury yield is still below the 2.60% level it was at two years ago or the 5% level of two decades ago.

“The concern isn’t that the 10-year is at 1.50%,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management. “It’s that it went from 1% to 1.50% in a handful of weeks, and what does that mean for the rest of 2021.”

Ma thinks it could keep rising above 2% by the end of the year, but he doesn’t see it going back to the old normal of 4% or 5%, which would force an even bigger reassessme­nt for markets. Until that becomes more clear, though, he says he’s looking for the stock market to stay volatile.

Aren’t stocks still really high?

Yes. Despite the recent pullback in the market, the major U.S. stock indexes remain near all-time highs set last month. The benchmark S&P 500 index and Nasdaq each hit all-time highs on Feb. 12. The Dow Jones Industrial Average set a record high Feb. 24. And the Russell 2000 index of smaller companies notched an all-time high on Feb. 9.

Is Wall Street still optimistic?

Yes, and one reason is that many investors agree with Powell and expect inflation pressures to be only temporary. That should hopefully keep rates from spiking to dangerous levels.

 ?? FRANK FRANKLIN II/ ASSOCIATED PRESS ?? Expectatio­ns for stronger growth, plus the higher inflation that may come with it, are pushing interest rates higher, making investors reexamine how they value every other investment.
FRANK FRANKLIN II/ ASSOCIATED PRESS Expectatio­ns for stronger growth, plus the higher inflation that may come with it, are pushing interest rates higher, making investors reexamine how they value every other investment.

Newspapers in English

Newspapers from USA