Higher bond yields have arrived.
The 10-year Treasury yield, which is closely tied to 30-year mortgage rates and other consumer loans, topped 1.5% on Thursday – its highest level in more than a year. Though it eased off of its multi-week climb Friday to 1.42%.
Well, these rising rates mean that investors have to consider what, if any, changes to make to their investments in the stock market, which they usually tap through plans like 401(k)s. They also need to think about the potential effects of the higher yields on their mortgages and car loans.
What's pushing yields higher yield? As the U.S. continues to climb out of its pandemic-induced recession, optimism has grown that further stimulus aid and widespread COVID vaccinations will help the economy expand rapidly later this year.
So rising bond yields typically signal that investors are hopeful for more economic growth in the future.
But they can also indicate that a potential spike in inflation is just around the corner.
The selloff in bonds this week pushed investors to rotate away from technology companies, which thrived in a stay-at-home economy, and opt instead toward companies poised to benefit from lockdowns ending.
U.S. stocks gyrated again Friday. On Thursday, the Dow Jones Industrial Average slumped 560 points after hitting a record a day earlier. The S&P 500 fell 2.5%, its worst day in nearly a month after touching an all-time high Feb. 12. The Nasdaq Composite, which is weighted heavily toward technology companies, shed 3.5% -- its worst day since October.
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Should you fear higher yields?
Some investors worry that an increase in bond yields and longer-term interest rates will end the market's runof steady gains. Remember, stocks have rebounded to record highs following a historic plunge last spring. These gains could be threatened because higher yields make it more expensive to borrow money, and that tends to slow down economic growth, which could be bad for stocks.
To be sure, inflation gains over the past year have remained modest. Economic disruption from the pandemic has continued to suppress demand and has kept inflation at extremely low levels. That has helped the Federal Reserve keep interest rates at record low levels in an effort to help lift the economy out of the recession.
Even before the pandemic, inflation over the past decade has remained muted, with annual price gains remaining well below the Fed’s 2% target.
If rates are rising because the economic growth outlook is picking up, higher interest rates shouldn’t be a risk for the stock market, experts say.
“Unless there is a sustained inflation surge, rising bond yields will have a minor impact on stocks,” Richard Saperstein, chief investment officer at Treasury Partners, a registered investment adviser, said in a note. “Bond yields are rising right now because the market is pricing in the reopening of the economy for the post COVID-19 world and accelerating economic growth.”
How quickly bond yields rise may be just as important as how far, experts say. Here’s how the moves could affect consumers:
How will higher yields affect stocks?
Stock investors shouldn’t be overly concerned about the recent rise in yields, according to David Lefkowitz, head of equities Americas at UBS Financial Services. That's because there is growing optimism about economic growth and rates are finally "catching up" to the bullish growth outlook in the stock market, he added.
In the past three months, the 10-year Treasury yield has risen by over half a percentage point, a rapid move that is larger than 90% of all the three-month periods since 1990, according to UBS Financial Services.
Still, stocks typically perform quite well during these periods. On average, the S&P 500 registers a 3.9% gain (16.5% annualized) when interest rates rise by more than half a percentage point, data from UBS Financial Services shows. While returns tend to be a bit lower in the three months after a big move in rates – 2.5% on average – they are no worse than a typical three month period.
The rise in yields does have implications for the stock market and could make shares of companies with high valuations less attractive. Those types of stocks tend to be technology companies, who are priced typically for growth and not for a steady return of dividends like consumer staples, utilities and real estate companies.
Rising rates tend to be favorable for more cyclical sectors, or companies whose businesses and stock prices tend to follow the business cycle. Those include sectors like consumer discretionary, energy, financials, industrials and health care.
Bank stocks, which were hurt by lower interest rates last year, would see higher profits if interest rates keep rising. And while the technology sector would be at risk for declines if yields rose due to higher inflation, the sector’s rising free cash flow and recurring revenue streams would provide protection, Saperstein said.
Investors are rotating into corners of the market that would benefit from the economy reopening. For the week, the energy and financial sectors in the S&P 500 were up 5% and 0.5%, respectively. Meanwhile, technology was down 3% for the week. Apple, Amazon, Facebook and Microsoft, companies that propelled the stock market higher in 2020, were all mildly higher Friday after each fell at least 2% on Thursday.
When are rising yields an issue?
Can yields and long-term rates rise too much before they begin to become a risk for stocks? In theory, yes, but typically only if a rise in rates begins to choke off economic growth.
Rising yields will likely inject more volatility into financial markets as investors debate when the Fed will be forced to tighten monetary policy, though that doesn’t appear to be anytime soon.
Fed chair Jerome Powell downplayed concerns this week about potentially higher inflation and signaled that the central bank sees no need to alter its ultralow rate policies for the foreseeable future. The Fed projects that inflation will remain at or below the central bank’s 2% target through 2023.
Despite conventional thinking that rising long-term rates are bad for stocks, historical data show that the broad S&P 500 has actually posted strong returns.
The S&P 500 has averaged an annualized total return of 13% and increased 81% of the time during rising rate periods (13 out of 16), according to data from Truist Advisory Services.
“With the pandemic winding down later this year, massive pent-up consumer demand, more fiscal stimulus on the way ... it's hard to see the recent rise in rates having a material drag on economic growth,” Lefkowitz said in a note.
Will this affect mortgage rates?
A number of consumer loans are influenced by the levels of the U.S. bond market, most notably mortgage rates.
Rising interest rates mean more expensive mortgages, which crimps affordability for prospective homebuyers. And if fewer people can afford homes, that also could cause real estate prices to stagnate or even fall, crimping the build-up in equity of current homeowners, analysts said.
Mortgage rates have increased in six of the past eight weeks, with the benchmark 30-year fixed rate last week climbing above 3% to its highest level since September, according to the Mortgage Bankers Association. As a result of these higher rates, overall refinance activity fell 11% to its lowest level since December, but remained 50% higher than a year earlier.
However, mortgage rates are expected to remain historically low and should support a modest increase in the pace of sales for the year overall, according to Oxford Economics.
“Homeowners can take advantage of the low rate environment by refinancing the mortgage, generating hundreds of dollars of savings each month and tens of thousands of dollars in savings over the life of the loan,” Greg McBride, chief financial analyst at Bankrate, said in a note.
This article originally appeared on USA TODAY: Bond yields: How will a surge affect your finances?