One of Wall Street’s loudest alarms is going off.
The 10-year yield has dropped 18 basis points this month, heading for its biggest slide since March 2020. It’s been a surprising turn of events for the stock market, and investors have had trouble digesting the yield’s slide, especially because it seemingly came out of nowhere.
While stocks have recovered since Monday’s sharp drop, it’s hard to shake the feeling that the stock and bond markets are looking at two vastly different economies.
Which side is right? Only time will tell, but this particular yield tantrum looks like early cycle uncertainty instead of an ominous warning.
Treasuries have a reputation on Wall Street for sniffing out signs of trouble.
When the tech bubble burst in 2000, the 10-year yield peaked two months before the stock market. Same deal before the Great Financial Crisis. The 10-year yield fell nearly 1 percentage point from June to September 2007, right before the stock market peaked in October. If stocks are the optimists trading on future growth, bonds are the pessimists watching for cracks in the foundation.
This time around, the drop in 10-year yields was speedy. That shocked market watchers, especially considering the talk about high inflation and blowout growth. The move was the first alarm for growth: Normally, yields rise when economic prospects are strong. Then, value stocks lost their footing, which hobbled the market’s progress and fueled more concern about the economy. Delta variant headlines were the straw that broke the camel’s back.
In a vacuum, this series of events would suggest that a storm could be brewing.
But there’s more to the story.
Noise vs. Signal
While yields may be worth watching, the bond market has been more noise than signal over the past several years.
This time around, yields have been especially noisy. While there’s clearly anxiety about the future, the outlook for economic data remains strong. Gross domestic product (GDP) and earnings growth are expected to be well above average through next year. In fact, S&P 500 earnings estimates continue to move higher as Wall Street becomes more optimistic about the future. Consumer confidence and savings balances are healthy. Supply chain issues, while concerning, still look to be temporary quirks.
What’s going on?
When you zoom out, it’s hard to be pessimistic. So, what are bonds seeing that stocks aren’t?
The Fed. When more investors buy Treasuries, prices rise and yields fall. Lately, the Federal Reserve has been one of the biggest buyers of Treasuries, purchasing $80 billion in Treasuries per month since the early days of the COVID crisis in order to keep markets functioning properly. This has put abnormal pressure on yields.
The taper. There has also been speculation that the Fed may decrease (“taper”) its pace of bond purchases in the coming months. That’d show the Fed feels good enough about the economy to pull back its support. But some fear that the Fed may be stepping back too soon and running the risk of harming economic growth. Hence, the dramatic swings in yields.
However, the Fed has been adamant that it’s watching for more improvement in the job market before making moves. This environment reminds us of the “taper tantrum” of 2013. Bonds had an especially tough time processing the taper speculation back then, leading to similar big swings in yields. But ultimately, the Fed’s taper didn’t upend the economy and the S&P 500 posted a 30% gain that year.
The alternatives. The global economy hasn’t recovered as quickly, which has led to international investors eyeing Treasuries over their own government’s bond yields. If you think a 1.2% 10-year yield is low, check out the 0.02% on Japanese 10-year debt or the -0.4% on German 10-year bunds. In a world starved for yield, Treasuries may be the cleanest shirt in a dirty laundry pile.
The uncertainty. Stocks have come a long way since 2020, but the bond market can’t let go of the uncertainty we’re facing. The Delta variant doesn’t help matters, making growth prospects more fragile. Still, there’s a significant population of vaccinated people, and widespread lockdowns in the U.S. look unlikely at this point.
The Bottom Line
The bond market can often be a reliable signal for the outlook. And when the future feels especially uncertain, it’s easy to become reactionary to moves in such a signal.
But this time around, it may make more sense to look at the big picture. When you zoom out, growth worries look overblown. And there are various distortions impacting the bond market, from Fed and foreign investor buying to institutional rebalancing.
Under the surface, this yield tantrum feels more like a growing pain than a smoke signal.
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Callie Cox, senior investment strategist, contributed to this article.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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