Why Stocks Are Nervous About Bond

Since the early 1980s, only twice has the 10-year Treasury yield surged nearly as much as the Federal Reserve has slashed interest rates—a rare event tied closely to rising inflation expectations. This unusual bond market behavior is now rattling stock market investors.

The benchmark 10-year Treasury yield, which influences borrowing costs for mortgages, corporate bond, and auto loans, has spiked to 4.77% from 3.6% in mid-September. This rise mirrors the Fed’s recent rate cuts totaling a full percentage point over three months, a departure from the typical pattern where long-term yields decline during monetary easing to ease financial conditions.

Torsten Slok, chief economist at Apollo Global Management, sees this as a warning signal from the market. Concerns about the U.S. fiscal outlook, declining foreign demand for Treasuries, or doubts about the Fed’s justification for its 2024 rate cuts could explain the anomaly.

Adding to the unease, strong December job gains and rising consumer inflation expectations have pushed inflation fears back into the spotlight.

Inflation remains the key factor behind these market moves. Recent data shows three-month annualized core inflation rates hovering around 3%, suggesting persistent price pressures.

Brian Mulberry, a portfolio manager at Zacks Investment Management, believes this marks the end of the Fed’s easing cycle, with interest rates likely staying elevated around 4%. If inflation worsens, the Fed could face pressure to raise rates—something markets are unprepared for.

The current scenario is reminiscent of 1981, when the Fed, under Paul Volcker, cut rates to combat a recession, but inflation expectations pushed the 10-year Treasury yield to a record high. Guy Haselmann, a former strategist, emphasizes that inflation expectations are the driving force behind today’s rising yields, overshadowing fiscal deficit concerns.

This environment of higher yields and inflation expectations could bring prolonged volatility to financial markets. Growth-focused sectors, small-cap stocks, and consumer discretionary companies may struggle, while utilities and more stable investments might offer some insulation.

As the 10-year yield approaches 5% and the 30-year yield nears 6%, some investors see potential buying opportunities.

The Fed faces a challenging path forward. With inflation still a concern, the central bank may adopt a cautious stance, potentially refraining from further cuts or hikes in 2025. For now, investors are bracing for elevated rates and a more turbulent market environment as inflation dynamics continue to unfold.