The S&P 500 is heading for its biggest monthly loss in 2023, due to surging Treasury yields as investors face the prospect of the Federal Reserve keeping interest rates higher for longer.
Scott Kronert, a US equity analyst at Citigroup, said in August that the yield on the 10-year Treasury note is out of the 3.5%-4% channel it was trading in, dragging down valuations in the stock market as it climbed. Phone interview. “It disrupts the model that has been in place for most of this year,” he said.
The US stock market has been falling this month as investors prepare for comments this week from Federal Reserve Chairman Jerome Powell at the Jackson Hole Economic Symposium in Wyoming expected on Friday. Investors are grappling with a jump in yields in August while also watching possible spillovers from troubles in China, the world’s second-largest economy.
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Although the Fed has slowed the pace of rate hikes this year on the back of easing inflation in the US, the yield on the 10-year BX Treasury: TMUBMUSD10Y jumped this month to its highest level since 2007, startling investors.
“Ironically, prices have been moving higher” when inflation is down “significantly” based on CPI moving averages over the past three and six months, said Rick Reader, chief investment officer, global fixed income at BlackRock. Asset manager global allocation investment team leader, in a phone interview.
The US stock market ended mostly lower on Friday, with the S&P 500 SPX
It posted its third straight week of losses, according to market data from Dow Jones. FactSet data showed that the widely watched index is down 4.8% so far in August, on track for its biggest monthly loss since December.
The Nasdaq Composite and Dow Jones Industrial Average also ended Friday with weekly losses. The tech-heavy Nasdaq has joined the S&P 500 for three consecutive weeks.
There is some concern among stock market investors that the strength of the US economy could cause the Federal Reserve to further tighten monetary policy, according to Reeder. He said that fear, along with an oversupply of US Treasuries, seemed to be affecting stocks.
“There’s this massive amount of bond issuance and liquidity drains that I think are starting to show,” Reeder said, referring to Treasury bills, or U.S. government debt maturing in a matter of months that has been ticking over 5% recently.
Scott Wren, chief global market strategist at the Wells Fargo Investment Institute, said on the phone that earlier this year the company pulled some money from the stock market, cutting technology stocks to invest in T-bills. That makes the company invest in stock market pullbacks, he said, with Wells Fargo predicting that the S&P 500 will end in 2023 at 4,100.
The S&P 500 ended Friday at 4,369.71, down 8.9% from its record close in January 2022, according to market data from Dow Jones.
In Wren’s view, “the Fed is not done raising rates” to combat viscous core inflation, and Chairman Jerome Powell may take the opportunity at the Jackson Hole meeting to signal to the market that the central bank is nowhere near cutting rates.
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Wren said Powell may continue to sound “hawkish” in asserting that the Fed may raise its benchmark rate again in order to bring inflation down to its 2% target.
President Powell is scheduled to speak at the Jackson Hole meeting on August 25.
“The US economy is actually doing very well right now,” David Kelly, chief global strategist at JPMorgan Asset Management, said in a phone interview. “I still think inflation can go down completely without a recession.”
Many investors have long worried that the Fed risks triggering a recession by continuing to raise interest rates after raising them quickly last year to tame soaring inflation.
In Kelly’s view: “Unless the economy cracks in some way, we almost certainly won’t get a rate cut this year.”
But Kelly expects the Fed to start cutting rates slowly in the spring of 2024 if inflation continues to ease toward 2%. He said the central bank would likely accelerate interest rate cuts if the labor market “starts flashing an orange light that we’re about to head into recession” with consecutive monthly job losses in non-farm payroll reports.
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Meanwhile, 10-year Treasury yields rose for five straight weeks, their longest period of increases since March, ending Friday at 4.251%, according to market data from Dow Jones. The rate eased slightly on Friday after ending Aug. 17 at the highest level since November 2007 based on levels at 3pm ET.
BlackRock’s Reeder fueled the rally in part to an oversupply of US government debt, the cascading effect of the Bank of Japan adjusting its yield curve control to allow its own 10-year yield to rise, and BX T-bills: TMUBMUSD06M offering competitive rates of around 5.5% with zero risk credit or term.
Kelly said that while the US economy is doing well, China is not. The country’s real estate sector is suffering while investors fear that the slowing economy may end up in recession.
A slowing Chinese economy could ease pressure on demand for goods, which could have a deflationary effect that helps lower costs for businesses, according to Citi’s Chronert. But he also warned that an economic downturn in China could hurt profits for US manufacturers and retailers that sell in the country.
Meanwhile, Kronert said “the earnings picture still looks very good for the second half of this year” for US companies.
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This leaves investors watching Powell closely as he tries to balance the risks of cooling the US economy too much in his attempt to keep inflation in check with a restrictive rate policy. The Fed last month raised its benchmark interest rate to a target range of 5.25% to 5.5%, the highest level in 22 years.
“If it starts waving a flag that it has to go up significantly from here to get to where inflation needs to be, that’s a problem,” Kronert said.