The 10-year US Treasury yield moved up to 2.96% yesterday and is now at its highest level since late 2013. Moreover, Treasury yields have been rising since the start of the year and will continue higher due to the Federal Reserve. Rising Treasury yields to hit the stock market later this year.
There are a number of reasons for this. First, higher Treasury yields entice investors out of stocks and into US Treasuries and other bonds. Higher yields draw investors into bonds because of better returns.
Mind you, the S&P 500 has a price-to-earnings ratio of 24.6-times — which corresponds to a 4% earnings yield. That makes stocks over-valued relative to the historical earnings yield of 6.4%.
Accordingly, it makes little sense for investors to hold stocks with an earnings yield of 4% when they can get a risk free yield of 3%.
On top of that, rising Treasury yields typically leads to a stronger US dollar. That’s because many yield-hungry foreign investors sell their own currencies to buy US dollar and Treasuries. Increased demand puts upward pressure on the US dollar.
A stronger US dollar hits the bottom line of US companies as exports by US companies become less competitive. On top of that, the profits US companies make abroad translate to fewer US dollars. A weaker bottom line eventually translates into lower share prices for US stocks.
Rising Treasury Yields To Hit The Stock Market Later This Year
US Treasury yields will rise further this year as the Federal Reserve (Fed) continues to raise rates and reduce its balance sheet. Indeed, the Fed is already well on its way of selling off its vast stockpile of US Treasuries.
Come October, it will liquidate $50 billion per month from its balance sheet. Assuming that about half that is US Treasuries (and the rest is mortgage-backed securities), US Treasury demand will decline by $25 billion per month. That adds up to $300 billion annually.
At the same time, the US government has gone on a spending and tax cut binge. This has blown out the US budget deficit for the next year. That deficit will be covered by the issuance of massive amounts of new debt. This onslaught of US Treasuries supply will collide head-on with declining demand to push Treasury yields higher.
Many market analysts contend the 10-year US Treasury yield could surge to 3.4%. Any such move could easily trigger an exodus from the stock market. Accordingly, investors need to get ready for rising Treasury yields to hit the stock market.