The rise in yields is a double-edged sword. It reflects optimism about the economy, but also gives traders reasons to worry.
The bond market dominated the conversation on Wall Street this week as yields on benchmark Treasury bonds, which help determine interest rates for borrowers ranging from first-time home buyers to international corporations, steadily rose to seven-year highs.
The increase is something of a double-edged sword. On the one hand, a rise in yields reflects the strength of the economy. At the end of Friday, after a report showed unemployment is at its lowest since 1969, the yield on the 10-year note — or what the United States government will pay to borrow money for a decade — was 3.23 percent. It hadn’t been that high since May 2011.
But as rates rise, borrowing will also become more expensive for consumers and companies, potentially slowing growth. Higher rates also change the balance of risk and reward for investors in other markets. Reflecting this, stocks fell, with the Standard & Poor’s 500-stock index ending the week down more than 1 percent.
The idea that growth will push interest rates higher, only for higher rates to slow things down again, reflects the cyclical nature of the economy. Right now, rates are somewhere in between — not high enough to hurt growth, but rising and making some investors wary as they do. Here’s what to make of it all.
The economy
Government bonds are known as safe haven investments. People buy them, instead of riskier investments like stocks, corporate debt and commodities, because they’re worried about something: the economy, war, politics, you name it.
Bond yields move in the opposite direction of prices, so yields fall during such rough patches.
Since the financial crisis hit a decade ago, yields have been pretty low. The yield on the 10-year note has spent much of the past decade below 3 percent. (The low point was under 1.4 percent in July 2016.)
Those yields prevailed even as the American economy recovered. That’s partly because the Federal Reserve took extraordinary steps to try to nurse the economy back to health. But it also reflected lingering doubts among investors about the expansion. Even recently, plenty of investors have doubted whether the economy could grow as a trade war erupted.
But grow it has, with gross domestic product expanding at an annual rate of 4.2 percent in the second quarter, and even some glass-half-empty types are becoming convinced that a recession isn’t in the cards any time soon. So yields are rising.
“Big picture, the economy is very strong,” said Tim High, an interest rate strategist at BNP Paribas in New York. “The employment market remains very strong.”
In fact, the worry has now switched to whether that growth will start to run too hot, leading to faster inflation and pushing the Fed to raise interest rates faster than it would like.
For now, High said, that isn’t something to worry about — which means investors should be spared any nasty economic surprises.
The Future
In the United States, we rely on a lot of debt to fuel the economy. And when the cost of that debt rises, it can drag on growth.
We’re about to find out how heavy that weight will be.
As we’ve said, for much of the last decade, long-term interest rates — which are essentially set by the Treasury market — have been quite low. Now rising rates are pulling other key borrowing costs higher.
Rates on conventional 30-year fixed-rate mortgages are above 4.7 percent, the highest level since 2011. Likewise, interest rates on 48-month new car loans have risen to more than 5 percent. They hadn’t been that high since 2012, according to the most recent data from the Fed.
Traditionally, cars and houses play a big role in the consumption-driven American economy. And if there’s a weak spot in the otherwise strong economy, it could be in these interest-sensitive sectors.
Sales of existing homes have slipped in recent months. They were flat in August, and are down 1.5 percent from the previous year.
Automakers have reported steep declines in sales in September. Part of that decline reflected hurricanes that caused flooding in the Carolinas. But higher interest rates and rising car prices are also pushing some buyers toward the used car market.
The Stock Market
We often talk about financial markets — stocks, corporate debt, government bonds, commodities — as if they existed in complete isolation from one another.
They don’t.
Changes in one can often have large effects on another. If oil prices fall, for example, that’s obviously going to pinch the earnings of the companies that pump oil and refine gasoline. That will affect the stock prices of those companies, and the stock market as a whole.
Likewise, higher yields on government bonds can have a subtle, but important, impact on the stock market. As rates move higher, they can persuade more and more people who’ve ridden the nearly decade-long bull market in stocks to take some of their winnings off the table and sock them away in government bonds.
Eventually, that could start to take the wind out of the stock market’s sails.
