The bond market is signaling that U.S. stocks could be headed for a sustained selloff as investors revise their expectations of the Federal Reserve’s benchmark interest rate and when it might start to come down.
The yield on the 2-year Treasury note has surged by 36.8 basis points in three days, its largest gain since June 14th, reflecting investor sentiment towards Fed policy rates going forward.
What does this mean for stocks? Let’s take a closer look.
Why the Sudden Shift?
The recent shift in the bond market is being attributed to Friday’s jobs data, which took economists and investors by surprise with 517k new jobs created; this was more than 100% higher than predicted in December’s median forecast from Wall Street Journal economists polled at that time.
Additionally, ISM services PMI accelerated 6 percentage points to 55.2 in January versus 49:2 in December – better than expected 50:4 consensus estimate.
Taken together, these two data points suggest that the economy is stronger than previously thought, which means that the Fed may not need to keep rates low for as long as previously thought.
How Will This Impact Stocks?
Higher interest rates tend to weigh on stock prices because they make borrowing more expensive and they offer competition to riskier investments like stocks. When rates go up, it signals that the economy is improving and inflation is picking up, which are both generally bad news for stocks.
In the short-term, we could see a selloff in stocks as investors adjust their portfolios to reflect the new reality of higher interest rates. However, in the long-term, a stronger economy usually means better corporate profits, which should support stock prices.
Conclusion:
The bond market’s recent surge suggests that U.S. stocks could be headed for a sustained selloff as investors revise their expectations of the Federal Reserve’s benchmark interest rate and when it might start to come down. While this may cause some short-term pain for stock investors, it is likely indicative of a stronger economy, which should benefit stocks in the long run.
