Rising bond yields could keep a choke hold on tech and growth stocks for now, as investors bet the Federal Reserve will raise interest rates four or more times this year.
Stocks tumbled Monday, with tech the worst performing sector as Treasury yields jumped. The Nasdaq was hard hit, slumping 2.6% while the S&P 500 lost 1.8%.
The 10-year yield, which moves opposite price, was at a new post-pandemic high of 1.87% Monday, after trading at just under 1.8% Friday. The 2-year yield also zipped higher, crossing above 1% to 1.04%. For perspective, the 2-year, which most reflects Fed policy, was just above 0.5% at the beginning of December.
“I think a lot of this is stemming just from the fact that people are starting to get even more aggressive on their Fed calls,” said Jim Caron, head of macro strategies, global fixed income at Morgan Stanley Investment Management. “It was two rate hikes and then three and now it’s four, and it could be more than four.”
Bond pros expect yields to continue to rise into the Fed’s meeting Jan. 25 and 26, and then will take their cue from the Fed’s tone. That could mean rough sledding for stocks. Yields rise as prices fall, and bonds are selling off as investors repostion ahead of the Fed meeting.
Caron said the market is full of hawkish chatter, like whether the Fed could possibly make a surprise hike in January or whether it could raise rates by a half percentage point in March, rather than the quarter point most expect. “The ante is being upped, and as people start discussing and talking about these things, the equity market doesn’t take it so well,” he said.
He said the fed funds futures market is pricing in four quarter point hikes for 2022, with the slight possiblity of more than a quarter point in March. There’s also a very slight chance of a hike in January being priced in.
The Fed had already set a hawkish tone when it met in December, but the minutes from that meeting showed central bankers were even more bent on tightening. The minutes revealed Fed officials had discussed shrinking its balance sheet starting this year. That is in addtion to the three quarter point rate hikes contained in its forecast.
But Fed speakers have also added to the speculation that more rate hikes are coming. St. Louis Fed President James Bullard last week said he could see four interest rate hikes this year. Fed Governor Christopher Waller Friday said three rate hikes would be a good baseline but there could be fewer, or as many as five depending on the course of inflation.
Bond strategists expect the closely watched 10-year yield will be on a quick path to 2%. The 10-year is important because it influences home mortgage rates and other business and consumer loans.
It is also the bond barometer the stock market watches most, and it’s moves can influence tech and other stocks that have high valuatoins based on expectations for their best earnings being in the future.
“How quickly do we get to 2% is going to be contingent on the Fed’s tone next week,” said Ian Lyngen, head of U.S. rates strategy at BMO. “And it’s going to be contingent on the performance of risk assets. I would expect we break 2% in the period between the January and March Fed meetings. The market has come into the year with sufficient momentum to get us there sooner rather than later.”
Lyngen then expects the rise in yields will slow and the 10-year will peak in the first half of the year. Between 2% and 2.25%, dip buyers should step in and slow the rise.
Caron said stocks are unnerved by swift moves in rates, and investors are now unsure how quickly rates will rise and where they will stop. For that reason, the Fed’s January meeting will be very important.
“That’s where the Fed is going to have to message out their game. I think at the Jan. 26 meeting they signal they are going to raise rates in March, and they also mention something about quantitative tightening and balance sheet run off,” said Caron. “Between now and then, why stand in the way of this?”
As for stocks, “I think it will be rocky, but I think ultimatley people will look at it and say what does this really mean. I don’t think it means a lot,” said Steve Massocca of Wedbush Securities. “The interest rate thing is probably a good thing. We had the spigot on too hot. To turn that down will ultimately be good for the stock market.”
Massocca said the choppiness will take some steam out of tech and high growth stocks the investments with high valuations that do well when money is cheap. For instance, former high flier ARK Innovatoin ETF was down 4.2% Monday, and is now off 18.7% for the month of January.
“Will this be the genesis of some major decline for the stock market? I dont’ think that’s true. It’ll be choppy and people will be nervous about it,” he said. “These super high growth stocks, the FANGs of the world, those valuations are excessive. This could be a reassessment of some of those valuations. That will ultimately be a good thing for the stock market.”
Massocca said he expects value stocks to outperform. Of the major sectors, energy was the best performer Monday, trading flat. An attack by Houthi rebels on the United Arab Emirates drove oil to a 7-year high.
The jump in oil prices added to the move higher in global bond yields, as investors looked at the prospect of more energy inflation. The 10-year German bund, for instance, saw its yield edge up, closer to zero, at minus 0.02%.