The yield on 10-year Treasurys hit 4.1% this week, a figure not seen since July, despite the onset of a rate-cutting cycle. This treasury yield has actually increased by about 0.5% since dropping below 3.6% on September 17, just a day before the Federal Reserve reduced its benchmark federal funds rate from the highest level in two decades.
Generally, rising yields unsettle stock investors for a few reasons. They can divert investment from the stock market which can subsequently lower stock evaluations by augmenting the yield on lower-risk fixed-income securities. They can also deter consumer and business borrowing, negatively impacting economic growth and corporate revenues.
However, recent weeks have seen rising Treasury yields not impede the stock market's performance. The S&P 500 recently reached its 45th record high of the year with the 10-year yield at a two-month peak. Major stock indexes have also reported positive growth over the past five weeks.
The current robustness of the U.S. economy has contributed toward maintaining corporate profits, with a growing belief amongst Wall Street experts that they will sustain. Regardless of whether the Fed’s rate-cutting cycle is aggressive or more cautious, it should generally favor business and stocks.
Analysts from Bank of America anticipate a growth of 15% in the S&P 500 earnings next year. They also predict growth to extend beyond the Magnificent Seven - Apple, Microsoft, Nvidia, Alphabet, Amazon, Meta, and Tesla - who majorly contributed the recent market performance and earnings growth. The remaining S&P 500 constituents, whose profits were either declining or stationary during 2023 and early 2024, are projected to experience double-digit growth in earnings over the next five quarters.
A Schroders study indicates that in 6 out of 11 periods between 1970 to 2021, stock valuations were constricted due to escalating yields. Despite this, stocks made progress in all but two of these periods, thanks to rapidly growing earnings.
Few experts predict the 10-year yield will rise significantly more than its current level, reinforcing the belief that yields are unlikely to disrupt the bull market.
With the U.S economy in a strong position and little chance of a near-term recession, analysts expect the Fed to continue with rate cuts next year. They forecast that the 10-year yield will hover at around 3.75% at the end of both 2024 and 2025.
Lawrence Gillum, Chief Fixed Income Strategist at LPL Financial, anticipates a slight increase in rates but generally sees yields oscillating between 3.75-4.25% for the remainder of the year.
The U.S. economy's unexpected resilience is one primary reason for the unusual discrepancy between interest rates and yields. Notably, a higher than anticipated number of jobs were added in September, resulting in a declining unemployment rate. On the other hand, inflation was slightly above target in the same month, leading to doubts about whether the Fed needs to aggressively continue with rate cuts to ward off an economic downturn. Previously, the market anticipated a further reduction of 75 basis points (0.75%) before the end of the year. According to recent data, this is no longer viewed as a likely scenario.