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Falling Yields Spreading Fear to US Stock Market

James Hyerczyk
Yields are plunging because investors are seeking shelter in bonds. Unlike previous drops in interest rates that have driven investors into stocks because of their higher yield, this time, investors are reallocating their money into Treasurys, which has contributed to the 4% drop in the S&P 500 Index in May.

The major U.S. equity indexes closed lower on Tuesday as another plunge in U.S. Treasury yields raised fears of a possible economic slowdown. The yield on the benchmark 10-year Treasury note fell to around 2.26%, its lowest level in 19 months, as investors continued to press for a rate cut by the Fed. Banks stocks were mostly affected by the drop in yields. Banking sector weakness was the primary drag on the S&P 500 Index.

All three major indexes started the session higher after a long, uneventful holiday weekend. Conditions shifted quickly as traders showed a delayed reaction to comments made by President Trump on Monday. Trump said the U.S. was “not ready” to make a deal with China, before adding he expected one in the future. Trump also said tariffs on Chinese imports could go up “substantially.”

On Tuesday, the benchmark S&P 500 Index settled at 2802.39, down 23.67 or -0.84%. The blue chip Dow Jones Industrial Average finished at 25347.77, down 237.92 or -0.93% and the technology-based NASDAQ Composite closed at 7607.35, down 29.66 or -0.39%.

Falling Yields Sending Warning Signal to Stock Market

This generation of investors is familiar with the following strategy: stocks plunge, money moves into Treasurys for protection. This time around, it’s the Treasurys dictating the movement in the stock market.

The rapid drop in interest rates is making mortgages and other household loans a lot cheaper, but it may be sending out a negative signal to stock market investors. Treasury yields have fallen sharply this month, as trade war fears rose and economic data disappointed.

Yields are plunging because investors are seeking shelter in bonds. Unlike previous drops in interest rates that have driven investors into stocks because of their higher yield, this time, investors are reallocating their money into Treasurys, which has contributed to the 4% drop in the S&P 500 Index in May.

The move toward lower rates is not just occurring in the U.S. The U.S. benchmark 10-year Treasury is also following Europe’s German 10-year bund yield, moving lower amid political and economic concerns.

As Patrick Palfrey, Credit Suisse equity strategist put it, “Interest rates are a barometer of what future expectations are. It’s a good gauge of what investors are focused on. If interest rates are falling, it’s likely the outlook is less bright.”

Sectors Weakening

It’s obvious that the broad-based indexes have been under pressure all month. What’s interesting is how the money has been rotating out of the sectors. At first it was the Technology sector, led by the Trump Administration’s move against Hauwei. Last week, it was the Energy Sector after oil prices plunged over 6% in one session after the U.S. released weaker-than-expected manufacturing PMI data. On Tuesday, plunging yields drove down the Banking Sector on fear of lower earnings.

If we continue to follow this progression then look for weakness to start developing in the Consumer Sector. As economic fear begins to spread and consumers become worried about their jobs, they’ll begin to spend less.

This article was originally posted on FX Empire

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