NEW YORK (AP): Interest rates continue to rise higher and Wall Street continues to shake because of this.
The ten-year Treasury yield rose above 1.50% on Thursday, boosted by comments from the Federal Reserve presidency and helped send shares to Wall Street on another slide. The speed with which the yield has increased has forced investors to re-examine how they value stocks, bonds and any other investment. And the immediate verdict has been to sell them at lower prices, especially last year’s most popular investments.
Yields have been rising optimistically for an economic recovery after a year of coronavirus-induced misery, along with expectations of the higher inflation that could accompany it. This is key because these returns form the cornerstone that the financial world uses to try to figure out the value of anything from Apple stocks to junk bond.
For years, yields have been very low for Treasurys, meaning investors earned very little in interest on owning them. In turn, this made stocks and other investments more attractive, which increased their prices. But as Treasury yields rise, so does downward pressure on the prices of other investments. Here’s why recent moves have been so painful:
WHY DO TREASURE INCOME INCREASE?
Part of it is rising inflation expectations, perhaps a bond investor’s worst enemy. Inflation means that future bond payments will not buy as much, as the price of a banana or bouquet will be higher than it is today. Thus, when inflation expectations rise, bonds are less desirable and their prices fall. This increases their performance.
Treasury yields also tend to follow expectations of a strengthening economy, which is rising. When the economy is healthy, investors have less need to own treasures, considered the safest possible investment.
WHY DO INCREASING RETURNS MEAN IN THE PRICE OF FALLING BONDS?
Suppose I bought a $ 100 bond that pays 1% interest, but I’m worried about rising inflation and I don’t want to stand still. I’m selling it to you for $ 90. Get more than 1% return on your investment, because recurring payments from the bond will continue to be the same amount as when you owned it.
WHY DO INFLATION AND GROWTH EXPECTATIONS ARISE?
Coronavirus vaccines are expected to hum the economies this year, as people feel comfortable returning to stores, companies reopening, and workers getting jobs again. The International Monetary Fund expects the world economy to grow 5.5% this year after falling from 3.5% last year.
A stronger economy often coincides with higher inflation, although it has generally tended downward for decades. Congress is also about to invest another $ 1.9 trillion in the U.S. economy, which could further increase growth and inflation.
WHY DO RATES AFFECT SHARE PRICES?
When trying to figure out what a share price should be, investors usually look at two things: how much cash the company will earn and how much should be paid for every $ 1 of that cash. When interest rates are low and bonds pay little, investors are willing to pay more for this second tranche. They wouldn’t lose much income if they had put that money in a treasury.
AND NOW WHAT RATES ARE THEY GOING UP?
The recent increase in returns is forcing investors to reduce the amount they are willing to spend on every $ 1 of the company’s future earnings. This raises difficult questions, especially when critics had already argued that stocks were approaching dangerous levels after their prices had risen much, much faster than profits.
Shares with higher prices relative to earnings are being severely affected, as are shares that have been bid for their expected profits in the future. Big Tech shares are in both fields. Shares that pay dividends are also hurt because investors looking for income can now turn to bonds, which are safer investments.
The ultimate concern is that inflation will soar at some point, which will send rates much higher.
ARE INTEREST RATES NOT REALLY LOW?
Yes, even at 1.54%, the ten-year Treasury yield is still below the level of 2.60% it had two years ago or 5% two decades ago.
“The concern is not that the ten years are at 1.50%,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management. “It’s that it went from 1% to 1.50% in a handful of weeks, and what that means for the rest of 2021.”
Ma believes it could continue to rise above 2% by the end of the year, but does not see it returning to the old normal of 4% or 5%, which would force an even greater revaluation for markets. Until that becomes clearer, however, he says he is looking for the stock market to remain volatile.
ARE THEY NOT VERY HIGH?
Yes. Despite the recent decline in the market, the main US stock market indices remain close to the all-time highs set during the last month. The S&P 500 is still within 4.2% of its February 12 record.
HAS THE FED NOT SAID THAT IT WILL KEEP INTEREST RATES LOW?
Yes. The Federal Reserve has direct control over short-term interest rates and President Jerome Powell has repeatedly said he is in no hurry to raise them. It also has no plans to cut its $ 120 billion in monthly bond purchases that are used to push down long-term rates.
Powell said the Fed will not raise its benchmark interest rate, now at its record low of zero to 0.25%, until inflation slightly exceeds its 2% target level. Powell has also repeatedly said that while price increases could accelerate in the coming months, these increases are expected to be temporary and not a sign of long-term inflationary threats.
Those statements echoed again on Thursday, but analysts said long-term yields were rising with disappointment that Powell did not offer anything more forceful to curb recent gains.
“We believe our current political attitude is appropriate,” Powell said.
IS WALL STREET FOLLOWING OPTIMISTS?
Yes, much of Wall Street still expects stocks to continue to rise. One reason is that many investors agree with Powell and expect inflationary pressures to be only temporary. Hopefully, this should keep rates from dangerous levels.
In addition, after a bleak 2020 for most companies, investors are betting that the growth in corporate profits will explode more as more people receive COVID-19 vaccines throughout the year and the economy s ‘gradually approaching normalcy. If profits increase enough, stocks may remain stable or may even increase, despite rising rates.
DO SOME COMPANIES GIVE WELL WHEN INCREASING RATES?
Financial companies, particularly banks, have recently won because rising rates could mean higher profits from various consumer loans, including mortgages. And if rates rise due to inflation problems, energy companies could benefit if prices for oil and other commodities also rise.
In general, however, rising interest rates are a problem for companies as loans become more expensive. This is especially painful for companies such as real estate investment trusts or REITs, which require a lot of money and often debt.
People who depend heavily on credit can also shrink, which could affect all types of businesses that depend on consumer spending.