Treasury yields could be peaking soon and that could ease some pressure on stocks

Published Wed, Oct 19 20222:04 PM EDTUpdated Wed, Oct 19 20223:17 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

The closely watched 10-year Treasury yield has been setting new 14-year highs, but strategists expect it to ease from those levels in a matter of weeks, relieving pressure on the stock market. That may be a temporary phenomenon, but it could serve to fuel the year-end rally that many investors have been expecting. The 10-year edged up to 4.12% Wednesday for the first time since 2008, while the whole yield curve moved higher. The 2-year Treasury yield, for instance, rose to 4.54% — its highest since 2007. "To me, what's necessary here is the 10-year yield just stops rising, reaches the peak level," said Jim Paulsen, chief investment strategist at The Leuthold Group. "The market could take off on that. It doesn't even need yields to come down." Bond strategists and technical analysts say there is some scope for the 10-year yield to reverse course. From purely a chart perspective, Fairlead Strategies' Katie Stockton said there are new countertrend signals that the yield has become overextended and it may fall back to 3.5%, or even 3.25% temporarily. "The implications of this signal we have are for nine weeks, and that basically goes until year-end," she said. Stockton added her primary chart point is 4% for the 10-year, and if it closes above that for a second Friday in a row this week, that could put a secondary longer-term target of 5.25% in play for next year. Stocks fell Wednesday as yields rose. Strategists have been watching for signs that the stock market is bottoming after Thursday's sharp move higher, which followed hot inflation data. But since then, rising yields have been an impediment. Higher yields pressure stocks for a couple of reasons. First, the technology and growth names that are most highly valued and trade more on the promise of future earnings do better when money is cheap. The higher yields also are at levels where they make fixed-income investments more attractive for investors seeking yield, and those investors could reduce stock holdings as a result. The 10-year is especially important since it influences mortgage rates and other consumer and business loans. The yield has been moving higher as traders await the Federal Reserve's next meeting; it is expected to raise the fed funds target rate by three-quarters of a percentage point on Nov. 2. "As we get out of the November meeting and the midterms toward the end of the year, it could rally back to that 3.25% to 3.5%, said Ben Jeffery, rate strategist at BMO. He said the longer-term trajectory will be determined by the economy. It will move differently depending on whether the Fed manages a soft landing, or if instead the jobs market deteriorates significantly and there is a hard landing. "If we continue to see strong hiring and a low unemployment rate that will keep rates higher ... the softer the landing the higher rates will be," said Jeffery. For now, the 10-year yield is moving higher, with the next level to watch 4.17%, he said. If that is surpassed, the yield could move to 4.25%. Yields move opposite price. Jeffery said yields on Wednesday were affected by the U.K. and Canadian inflation reports and could keep drifting higher until there is a catalyst. "There's not really anything fundamentally relevant. We do get GDP next week, and then after that is the Fed meeting itself," said Jeffery. He added that the midterm election will be very important for bonds, because it will remove uncertainty over which party controls Congress. Yields could move lower after the Nov. 8 election if Democrats lose one or both chambers of Congress. Currently, Democrats are expected to lose the House and possibly the Senate. "If Democrats retain both houses of Congress that would be higher potential for larger spending," he said. That means more debt and higher yields. If Republicans win one or both houses, it means gridlock. Paulsen said there is precedent for Treasury yields to stop rising even before the Fed is done raising rates. One example occurred before the 1990 recession. The Fed raised rates in April 1988 and boosted them by more than 3% in the next year. "Despite consistent and aggressive Fed tightening until March 1989, the stock market low was already in before the Fed began its campaign; in August 1988, the S & P 500 surged higher once the 10-year yield peaked near 9.5%," Paulsen noted. "Even the 1990 recession did little to slow the stock market. Like 1984, stocks turned up long before the Fed blinked, but not until the bond market peaked," he added. Another example he cited was in 2018, when the 10-year peaked in November, but the S & P 500 fell more than 10% in less than a month. Paulsen said the sharp loss in stocks was fully recovered by early February 2019. The S & P 500 then rose to a record high and Treasury yields fell, even though the central bank did not pull back its target funds rate until July 2019.