Rising Inflation Expectations, Rising 10-Year Treasury Yields (Reason To Worry Or Not?)

Last week the S&P 500 rallied 4.3% after a quick downdraft at the end of January and into the first week of February that zapped gains on major indices for the year and sent the S&P and the Dow into corrective mode (down 10% from recent highs), albeit briefly.

That rally from early February lows made for the biggest S&P weekly gain in more than 5 years and got the stock indices back in the black for the year (+1.0% YTD for the S&P 500 through Feb. 21st). The 3 major indices (S&P, Dow & Nasdaq) have now gained back nearly half of their losses from earlier in the month.

The February 5th drop of 1,175 points for the Dow was the largest single-day point loss ever, but in percentage terms that was a -4.6% decline, one that doesn’t register in the top 100 largest single-day losses.

It seems as if a lot of records are being broken as of late, except at the winter Olympics. It looks like the U.S. haul of 37 medals in 2010 in Vancouver will stand. We’re at 19 in PyeongChang as I write this (Feb. 21st evening). In the end, hopefully we appreciate witnessing exciting competition by great athletes regardless of their nationality as the modern Olympics’ aims are for “better world through sport practiced in a spirit of peace, excellence, friendship and respect.”

I won’t speculate on the rationale for lower overall medals for U.S. Olympians but as for the recent equity market sell-off it’s mostly tied to inflationary expectations which feeds through to interest rates, particularly those on the 10-year Treasury note, the most popular debt instrument in the world.

For borrowers, the 10-year is the benchmark for fixed-rate mortgages and the pricing of other credit assets (such as corporate bond rates which trade at a spread over Treasury yields). Overall, think of the 10-year as a gauge of domestic economic growth.

With a tight labor market showing some wage growth and a recent higher-than-expected consumer price inflation (CPI) report, we’re seeing upward pressure on interest rates. Those types of inflationary signs ultimately work their way through to companies as cost pressures, thus potentially hurting profit margins – that’s when stocks start to get roughed up.