PMC Weekly Review - April 27, 2018

A Macro View: “10-Year Treasury Yield Hits 3% - Should We Worry?"

The yield on the 10-year Treasury Note crossed 3% this week for the first time since 2014, drawing much attention and causing stocks to sell off, but what does it really mean for investors? The 10-year yield is an important indicator for financial markets, as it influences borrowing costs for both consumers and corporations, affecting everything from mortgage rates to corporate debt. The rise in the benchmark yield typically signals expectations of rising interest rates and rising inflation, and also is generally indicative of economic growth.

So why does the 10-year yield crossing 3% have people worried? The 3% threshold represents a psychological level of sorts for many investors, as they have become used to lower rates driven by years of quantitative easing. But now that it has reached 3%, many worry that it could trigger a negative reaction from financial markets. But is that fear justified?

The yield on the 10-year Treasury Note is a key benchmark for long-term interest rates: When it rises, it costs more to borrow. This affects spending at both the corporate and consumer level and, ultimately, could have a negative impact on the equity markets. Lower rates are generally viewed as more favorable for the stock market. That’s because higher rates mean less borrowing and less spending across the board. This often leads to lower earnings, resulting in decreased stock prices. Rising long-term yields also make equities look less attractive, as investors flock from riskier assets to the perceived safe haven of Treasurys.

So when the yield rises, many investors worry that markets will fall. Although it’s true we haven’t seen the yield on the 10-year Treasury Note at these levels for a few years now, it’s important to remember that even though 3% feels relatively high in the current environment, by historical standards, 3% is still quite low. Investors also should bear in mind that rates have been artificially depressed due to years of quantitative easing by the Federal Reserve, and that higher rates are to be expected. Rising Treasury yields still typically indicate a stronger economy, and history has shown that stock prices can still go up even when rates are rising. Eventually, rates will likely rise enough to affect the economy, but for now, strong economic underpinnings suggest that a recession is unlikely in the near term. Markets have since rebounded from the tumble they took on Tuesday, and the yield on the 10-year Treasury Note has dipped back below that 3% threshold since its initial crossing (though it may not stay there). For the time being, the economy continues to show signs of strength, and investors shouldn’t panic about the 10-year Treasury Note crossing this psychological threshold.

Rachel Mandeix
Associate Investment Analyst

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