Friday's Market Minute: Listen To The Bond Market

The yield on the benchmark 10-year Treasury rose above 1.07% on Thursday, hitting its highest level since March. The 5-year forward inflation expectation rate hit nearly a two-year high of 2.05%. The yield curve is steepening, with the longer-duration yields tracking the inflation expectations higher. The spread between the 10- and 2-year yields has risen to 96 basis points, the highest level since July 17, 2017.

It has been 4 months since August when the Fed changed its approach to monetary policy to allow for higher-than-historical-average inflation. The central bank hopes to meet its 2% target on an average basis by letting prices drift higher for some time to offset years in which inflation had been weak. Based on how bond prices fell this week, it appears additional government stimulus via a Democratic-led Congress will swiftly legislate more debt into existence. This spending might be on the way to help battle the economic fallout of the pandemic, while serving the added function of facilitating the central bank’s new monetary policy approach.

2020 brought new all-time highs for the tech sector, and 2021 keeps on giving as the Dow and S&P follow at record highs. Euphoria has engulfed emerging technology stocks in alternative energy, artificial intelligence, industrial printing, genomics, blockchain, and bitcoin. However, we must keep in mind that a big argument for buying U.S. stocks now at such high valuations is their value relative to extraordinarily low bond yields. As Treasury yields rise due to another economic aid package, that relative advantage may become diminished. Every stock market correction is based on the convergence of different circumstances. The recent shift in long-term treasury yields could become the reason for an equity market correction.

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