Dow plunges 800 points as bond fears haunt stocks

Ivan Schwartz
February 12, 2018

Stocks closed lower Wednesday, but not before swinging wildly to sharply higher and lower levels, as interest rates rose.

US stocks saw their biggest one-day fall in six years on Monday, as investor profit taking brought the market back down from record highs seen in late January, after benchmark bond yields rose to a four year high last week.

The bipartisan spending bill, expected to pass Congress, called for a higher-than-expected spending cap of $300 billion. A soft 10-year auction added to the jump in yields, which move opposite prices.

The dollar index rose 0.23 percent, with the euro down 0.12 percent to $1.223. The move was its biggest one-day reversal since February 2016.

U.S. equity markets have been in a euphoric state since President Donald Trump passed his historic Tax Cuts and Jobs Act reform, which saw corporation tax cut from 35% to 21%.

An improving outlook internationally is adding to pressure on global fixed income markets.

The U.S. Dollar posted its biggest one-day gain in more than three months against a basket of major currencies on Wednesday, helped by higher U.S. Treasury yields and geopolitical concerns in Europe. It's been pretty ugly.

The question for investors is how high do yields go.

Jim Caron, portfolio manager at Morgan Stanley Investment Management, said he expects the range for the 10-year now to be 2.50 to 3.25 percent.

"If 2.88 scared people why would they be comfortable with 2.84/2.85", said Schumacher. Why do rising bonds hurt stocks?

The yield on the 10-year Treasury bond ticked higher again on Thursday morning, to 2.88%.

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"You could get into a little bit of circular logic here, as you hand leadership back and forth". The acceleration of the Treasury bond market sell off has now spread contagion to U.S. equities and global risk assets.

While those concerns have been the catalyst for recent selling, the retreat in equities had been long awaited by investors as the market climbed nearly steadily to record highs earlier this year.

Nothing points to bonds suffering a calamity such as the stock market experienced after Lehman Brothers' 2008 collapse.

"I think there's going to be an interplay between equities and rates probably for the next several months, until we get greater clarity on how the overall growth outlook is going to be and if the Fed is thinking about shifting the reaction function", said Mark Cabana, head of USA short rates at Bank of America Merrill Lynch.

Worries that rising bond yields signify stiffening resolve at the Fed against inflation underpin another bear case for equities: That higher finance costs will slow the economy.

In the States, several members of the U.S. Federal Reserve are also expected to deliver remarks. Even before the budget deal, the Treasury is ramping up new debt issuance to pay for tax cuts and entitlements.

Strategists say the level of the yield is not so much the problem.

"I would not be at all surprised if bond yields get beyond 3% by the end of the year as a result of inflation". "At the margin, the buyer, the asset owner, is slightly enticed to put more money into fixed income than into the equity market".

Yields in the belly of the curve are down about 10 basis points. Still, that's a long way from the double-digit interest rates of the early 1980s. The ECB [European Central Bank] cut their quantitative easing in half.

"Over the last half a dozen of years we have been saying equity valuations can be higher because we are living in a low interest rate and low inflation environment but that's reversing a little bit and that's what we are staring at now", said Art Hogan, chief market strategist at B. Riley FBR in NY.

Simply put, when a country's macro-economic situation deteriorates, bond prices fall and bond yields rise, as investors seek more return on bonds to compensate for the risk involved.

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