NEW YORK (AP) – Interest rates continue to rise and Wall Street continues to shake as a result.
The yield on the 10-year Treasury climbed back above 1.50% on Thursday, boosted by comments from the Federal Reserve Chairman, and it helped stocks on Wall Street take another slide. The speed at which returns have increased has forced investors to rethink how they value stocks, bonds and any other investment. And the immediate verdict was to sell them at lower prices, particularly the most popular investments of the past year.
Revenues have risen with optimism for an economic revival after a year of coronavirus-induced woes, along with expectations for the higher inflation that could accompany it. That’s the key, because those returns are the foundation the financial world uses to figure out the value of anything from Apple’s stock to a junk bond.
For years, returns for Treasurys were ultra-low, meaning investors earned very little interest to own them. That in turn made stocks and other investments more attractive and drove up their prices. But as government bond yields rise, so does the downward pressure on prices for other investments. Here’s a look at why the recent moves were so rocky:
WHY ARE THE REVENUES OF THE ESTIMATE COSTS UP?
Part of that is rising inflation expectations, arguably a bond investor’s worst enemy. Inflation means that future bond payments will buy less – because the price of a banana or bunch of flowers will be higher than it is today. So when inflation expectations rise, bonds are less desirable and their prices fall. That increases their yield.
Government bond yields also often follow expectations for the strength of the economy, which are rising. When the economy is healthy, investors have less of a need to own Treasurys, which are considered the safest investment possible.
WHY DO FALLING TIE PRICES MEAN RISING REVENUE?
Suppose I bought a bond for $ 100 that pays 1% in interest, but I’m worried about rising inflation and don’t want to be stuck with it. I’ll sell it to you for $ 90. You will get more than 1% return on your investment because the bond’s regular payouts are still the same amount as when I owned it.
WHY ARE INFLATION AND GROWTH EXPECTATIONS ON THE RISE?
Vaccines against the coronavirus will hopefully keep the economy humming this year as people feel comfortable returning to stores, reopening businesses and getting employees back to jobs. The International Monetary Fund expects the world economy to grow by 5.5% this year, after the 3.5% decline last year.
A stronger economy often coincides with higher inflation, although it has generally been on a downward trend for decades. Congress is also close to pumping another $ 1.9 trillion into the US economy, which could further boost growth and inflation.
WHY DO THE RATES AFFECT STOCK PRICES?
When investors are trying to figure out what the price of a stock should be, investors often look at two things: how much money the company will make and how much they will have to pay for every $ 1 of that money. When interest rates are low and bonds pay little, investors are willing to pay more for that second part. They wouldn’t miss out on much income if they had put that money in a treasury instead.
AND NOW THE PRICES ARE RISING?
The recent rise in yields is forcing investors to cut back how much they are willing to spend on every $ 1 in future corporate income. That raises tough questions, especially when critics had already argued that stocks were approaching dangerous levels after their prices outpaced profits much, much faster.
Stocks with the highest prices relative to earnings are hit hard, as are stocks that have bid on their expected earnings well into the future. Big Tech stocks are in both camps. Dividend-paying stocks are also being hurt because investors seeking income can now turn to bonds instead, which is safer.
The ultimate concern is that at some point inflation will rise, making rates much higher.
ARE THE INTEREST RATES NOT YET REALLY LOW?
Yes, even at 1.54%, the yield on 10-year Treasury bonds is still below the 2.60% level of two years ago or the 5% level of two decades ago.
“The concern isn’t that it’s 10-year at 1.50%,” said Yung-Yu Ma, lead investment strategist at BMO Wealth Management. “It’s that it went from 1% to 1.50% in a handful of weeks, which means for the rest of 2021.”
Ma thinks it could continue to rise above 2% by the end of the year, but he doesn’t see it going back to the old 4% or 5% norm, which would force an even bigger reassessment for the markets. But until that becomes clearer, he says he’s looking to the stock market to stay volatile.
ARE NOT REALLY HIGH STOCK?
Yes. Despite the recent downturn in the market, the major US stock indices have all remained close to their all-time highs over the past month. The S&P 500 is still within 4.2% of its record on February 12.
DIDN’T THE FED SAY IT WILL KEEP INTEREST RATES LOW?
Yes. The Federal Reserve has direct control over short-term interest rates, and Chairman Jerome Powell has repeatedly said it is in no rush to raise them. It also does not intend to cut its $ 120 billion in monthly bond purchases used to put downward pressure on longer interest rates.
Powell said the Fed will not raise its benchmark interest rate, now at its lowest level of zero to 0.25%, until inflation is slightly above the 2% target level. Powell has also said repeatedly that while price increases may accelerate in the coming months, these increases are expected to be temporary and not a sign of long-term inflation threats.
He echoed those statements on Thursday, but analysts said long-term interest rates rose amid disappointment that Powell didn’t offer anything more vigorous to dampen recent gains.
“We think our current policy stance is appropriate,” Powell said.
IS WALL STREET STILL OPTIMISTIC?
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. That should hopefully prevent rates from rising to dangerous levels.
Even after a bleak 2020 for most companies, investors think corporate earnings growth will explode higher as more people receive COVID-19 vaccines throughout the year and the economy gradually approaches something near normal. If earnings rise sufficiently, stocks can remain stable or even go higher, despite a rise in interest rates …
ARE SOME COMPANIES DOING GOOD WHEN RATES RISE?
Financial companies, especially banks, have been making gains of late as rising interest rates can lead to bigger gains on a variety of consumer loans, including mortgages. And if rates rise due to inflation concerns, energy companies can benefit if prices rise for oil and other commodities as well.
In general, however, rising interest rates are a drag on businesses as they make borrowing more expensive. This is especially painful for companies such as real estate mutual funds or REITs, which require a lot of money and often debt to operate.
People who rely heavily on credit can also make cutbacks, which can have a ripple effect on all types of businesses that rely on consumer spending.