As Treasury Yields Soar, Should Stock Investors Worry?

The stock market has seen quite a bit of volatility so far in 2023. Despite having rebounded convincingly from 2022’s bear market, major stock market benchmarks remain below their all-time records from 2021. Many individual stocks remain far, far below their highest levels.

One culprit that many market commentators have blamed for the stock market’s ups and downs is the bond market. Treasury yields have been on the rise lately, and one key metric just hit levels not seen in 16 years. With so many things happening in the bond market that are unfamiliar to newer investors, the question many are asking is whether those who prefer investing in stocks should be concerned. Here’s an overview of what’s going on and the level of worry it’s causing across the stock market.

Ongoing gains in bond yields

Interest rates in the bond market have continued to go up, and unlike what was happening this time last year, the moves higher in rates are showing up pretty much across the market. The Federal Reserve’s aggressive campaign to raise short-term interest rates showed up immediately in the shorter end of the Treasury market, with yields on Treasury bills maturing in the next three to 12 months having moved above 5% a while ago. Early on, though, most bond investors thought those high rates would be short-lived, and so yields on longer-maturity bonds stayed relatively low.

Now, rate increases are no longer limited to the short end of the Treasury spectrum. The yield on the 30-year Treasury moved above 5% earlier this week for the first time since 2007. That has also had an impact on consumers, because most mortgage rates are tied to longer-term Treasuries. Interest on a typical 30-year mortgage has moved up to about 8%, and that has already had a slowing effect on home-buying activity and mortgage lending.

Image source: Getty Images.

Moreover, many bond market watchers don’t see rates on Treasury bonds coming down anytime soon. They point to factors like high U.S. budget deficits adding to the massive amount of total government debt, as well as the stubbornly strong economic environment that has thus far defied calls that a recession is imminent. It’s also still quite possible that the Fed will move to raise short-term interest rates still further before the end of the year, which could exacerbate concerns about how long rates could stay high in order to fight inflation.

The haves and have-nots in the stock market

Some people argue that the turmoil in the bond market is bad news for stocks. They note that if investors can safely guarantee themselves a 5% return by investing in Treasury bonds, then it could take away some demand for stocks as an investment.

Admittedly, many income investors were reluctant to move toward dividend stocks and other income-producing investments when bond yields fell below 1%. These more risk-averse investors will likely be happy to get back over to the bond market.

On a more granular level, though, the impact of high rates on stocks varies from company to company. Some businesses took on large levels of debt when interest rates were low, taking advantage of rock-bottom financing costs to pursue ambitious growth projects. These companies now face the challenge of either paying off the debt or refinancing at much higher rates, and either option puts a strain on their financial condition.

On the other hand, some companies have amassed huge cash balances. For them, higher rates mean extra income from their cash hoards — sometimes helped by having locked in much lower rates through long-maturity bond issuance in recent years. For these companies, high rates could actually boost their performance in the short run.

Just getting back to normal?

Despite rates having reached levels not seen in years, it’s important to recognize that these rates still aren’t abnormal by long-term historical standards. Indeed, one could argue that it was only aggressive intervention from the Fed that kept rates as low for so long. Now that that’s going away, investors should get used to greater volatility in the bond market and learn what impact it has on the companies whose shares they own.