The closely watched benchmark 10-year Treasury yield has made a rapid run higher, and it is edging toward a level where strategists say it could become problematic and be a key test for stocks. The benchmark 10-year yield touched 2.9% Tuesday for the first time since late 2018, a period when the stock market was selling off and the Federal Reserve was raising interest rates. As the Fed has moved to tighten policy, the yield has raced higher, from 1.5% at the start of the year to its current level just below 3%. On its way, the rising yield has pressured stocks, particularly growth and tech names that don't fare as well in a high interest rate environment. Now, strategists are watching for a point where the 10-year yield could cause broader pain, as interest rates compete with stock market yields and make borrowing costs higher for corporations across the board. Ben Jeffery, rate strategist at BMO, points out that the 10-year was at 1.66% on March 7, in the week going into the Fed meeting where the central bank raised its target fed funds rate from zero . The Fed has since become more aggressive and is now expected to boost the rate by another 50 basis points on May 4. Fed officials are also expected to add more tightening pressure by announcing a plan to shrink the nearly $9 trillion balance sheet, which holds mostly Treasury and mortgage securities. "I think the next question is how stocks handle all of this, and at what point do 10s at effectively 3% look too attractive for people to sit on the sidelines?" Jeffery said. Yields move opposite price, so if buyers stepped in at 3%, they could drive yields lower. Stock strategists say 3% would be an important psychological level for stocks, and it could cause some selling. But the real level of worry could come up quickly behind that when the yield reaches 3.25%. "It's really that 3.25% is the real number because in the double tightening cycle of the fourth quarter of 2018, when the Fed was raising rates and doing QT, 3.24% was the high close," said Peter Boockvar, chief investment officer at Bleakley Global Advisors. QT references "quantitative tightening," similar to the Fed's current plan to reduce its balance sheet. Katie Stockton, founder of Fairlead Strategies, said the charts support that view, and 3.25% could be an important test for the stock market. "Resistance is called that for a reason. It would be a very natural place for a corrective phase to unfold," she said. Stockton said the 10-year yield has been gaining upward momentum and is now in a trend to go higher. It will be important to see if it's just noise or whether it threatens stocks "if it's the real several month corrective phase. You would expect some kind of significant correction from that level." She said the 10-year yield had two episodes at 3.25% in the fall of 2018. It touched 3.26% in the week of Oct. 12, and the S & P 500 was down 4.1% that week. It touched it again Nov. 7, when the 10-year was at 2.485%, BMO's Jeffery noted. "We're still calling for a [stock market] bounce here, after which we're looking for a pretty good corrective phase and maybe it's associated with 3.25%," Stockton said. She said the action in 2018 does suggest the stock market's decline was highly associated with the move in yield. The selling reached a crescendo with a large downdraft in stocks in the shortened Christmas Eve holiday session. After that, the stock market bounced. As for the bond market, yields fell as stocks floundered. "Stocks freaked and we rallied down to 2.54% on Jan. 4," Jeffery said of the 10-year. "Stocks fell off a cliff, and the Fed stopped hiking." The Fed began a rate-cutting cycle in 2019. Jeffery said it's not clear where the lever on rates will be for the stock market this time. "It's not really a magic level. It's one of those things we'll know when we get there," he said. The market expects the Fed could move rates the equivalent of eight quarter-percentage-point hikes by December, with some increases of 50 basis points. That has created concerns the Fed could send the economy into a recession if it tightens too aggressively, particularly since it is also planning to reduce the balance sheet at the same time. "The question then becomes how much does the Fed want to push this?" said Quincy Krosby, chief equity strategist at LPL Financial. "There's a growing sense that the market needs to sell off in order to demonstrate that the market gets the Fed's message." But at what point, would a sell-off in equities hurt financial conditions and impact the Fed's plans? She noted the Fed this time is fighting high inflation, unlike 2018, but that inflation could start to come down. "If [the 10-year] starts going above 3%, then to 3.25% and 3.5% ... how far are they prepared to go? It's not just about raising rates. It's about draining the liquidity that was Covid-induced," she said.
Traders on the floor of the NYSE, March 28, 2022.
The closely watched benchmark 10-year Treasury yield has made a rapid run higher, and it is edging toward a level where strategists say it could become problematic and be a key test for stocks.