Stock Market Struggles with Rising Treasury Yields: A Familiar Problem Resurfaces

Stocks are facing a familiar problem as the market struggles to climb higher consistently despite better-than-expected earnings for the first quarter. The main challenge comes from rising Treasury yields, which are weighing on sentiment for equities and reminding investors of the period in 2023 when higher yields sent stocks crashing.

Piper Sandler chief investment strategist Michael Kantrowitz highlighted the systemic problem higher rates pose for equities in a recent note to clients. He pointed out that whenever Treasury yields have risen, stocks have fallen, and with yields soaring in recent weeks, the S&P 500 has declined by about 3%.

Kantrowitz emphasized the difficulty of seeing equities rise without rates going down, as evidenced by the inverse relationship between yields and stock prices. The two-year Treasury yield hitting 5% has been flagged as a key technical level that weighed on stocks during last year’s bond-driven sell-off, and the recent decline in stocks coincided with the two-year yield reaching 4.98%.

Investors have scaled back their bets on Federal Reserve interest rate cuts this year, shifting from expectations of nearly seven cuts to just one in 2024. This change in sentiment has contributed to the rise in yields, with market expectations pointing towards a more hawkish stance from the Fed.

Despite recent hot inflation readings, economists do not expect Fed Chair Jerome Powell to signal a dovish turn during his upcoming press conference. Powell is likely to reiterate prior comments indicating that policy needs more time to work before any rate cuts are considered.

The rise in yields has also explained why the S&P 500 is down nearly 3% this month, despite companies exceeding earnings estimates by an average of 9% for the first quarter. The pressure on valuations from higher rates has dampened stock price reactions to positive earnings reports.

Looking ahead, strategists anticipate that certain parts of the equity market, particularly stocks with weak balance sheets, may lag if rates continue to climb. While higher rates are not insurmountable for stocks overall, the trend of rising yields is expected to persist in the near term.

In conclusion, the stock market’s biggest challenge in 2023 remains the impact of rising Treasury yields on equities. Investors are closely watching the relationship between rates and stock prices, as well as the Federal Reserve’s stance on interest rate policy. As the market navigates these challenges, it is essential for investors to stay informed and adapt their strategies accordingly to navigate the evolving landscape of financial markets.