Rising Bond Yields Weigh On Wall Street

Trader Gregory Rowe works on the floor of the New York Stock Exchange on Friday

One big sign - much higher wage growth - was apparent in last week's U.S. jobs report, and now markets are scrambling to process the implications.

The Dow's drop Monday was its biggest in terms of points, but it had a larger percentage drop as recently in 2011. The index gave up 500 points in a matter of minutes Monday afternoon as Wall Street wags tried to decode events. Jerome H. Powell was sworn in as the 16th chairman of the Federal Reserve on Monday, after the departure of his predecessor, Janet L. Yellen.

What makes this past week's market drop particularly noticeable for investors is how rare a decline has been for stocks.

The first chart below compares the five-year government of Canada bond yield with the S&P/TSX utilities index.

Theoretically, when bond yield rises, the opportunity cost of investing in other assets, including equities, rises.

In its absence, yields on 10-year Treasury notes, which move opposite to their price, have surged to a four-year high above 2.8%, while stocks posted their sharpest one-day point decline since the financial crisis Friday.

But why are rising bond yields hurting equities? The second component is the difference between the TIPS yield and the nominal Treasury yield.

Even after this week's sell-off, stock markets remain at historic highs.

"Well on Friday that pull-back occurred with the Dow Jones falling over 600 points or 2.5%".

Last week, rising bond yields prompted the Bank of Japan (BoJ) to intervene in the bond market for the first time since July previous year.

Now investors are anxious that inflation might pick up even faster, forcing the Fed to raise rates to 2.5 or even 3 percent this year. Companies are healthy, and investors have rewarded them by pushing up their stock prices. By that measure, the price-earnings ratio, the S&P 500 is close to the most expensive it's been in many years, adjusted for inflation.

I do not think the NZ economy has improved so much compared to the USA to justify our bonds trading at an interest rate on par with U.S. bonds. "It's not setting some new kind of record other than its rapid ascent". (In a six-month span, the S&P 500 fell 45 percent.) Gross himself says the bond bear market will be a "mild" one.

Investors have spent much of the a year ago shrugging off geopolitical and economic risks, from the threat of nuclear conflict with North Korea to a potential trade war with China.

In early European trade London dived one percent, while Paris and Frankfurt each shed 0.9 percent.

Many hailed the bounce in the markets over the last week as part of the natural ebb and flow of stocks. If yields continue to rise, it could further confirm the breakdown of the more-than 30-year bull run.

The market volatility arrived last week after an unusually long period when it appeared there was no stopping its upward march.

But historically, pullbacks for stocks are normal, and investors shouldn't be surprised if stocks drop by 5 per cent or even 10 per cent before they begin rising again.

On Friday, the Labor Department put out its monthly report on how many jobs were created in January in the United States and how fast wages are growing. The reality is that the pace of rate increases may largely be dictated by economic data, particularly indicators of inflation.

US Treasury debt has been flashing warnings of incipient reflation for months, with benchmark 10-year yields rising 75 basis points since mid-September.

After a year of steady gains, the market has started to give some of those gains back.

"The service side of the economy was very robust in January", Tilley said.

Global investors are also trying to navigate a changing economic backdrop. In Japan, stocks were down more than 5 percent in morning trading, while shares in Hong Kong were down more than 4 percent.

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