One potential threat to the stock market may be playing out
- The U.S. Department of Treasury is expected to sell $258 billion worth of debt this week.
- If there's too little demand for those Treasury notes, bond yields could creep up further, said Mihir Worah, PIMCO's chief investment officer for asset allocation and real return.
- That's a worry for stock markets, Worah added.
As investors come to terms with the impending end of easy monetary policy, a new threat looms: The heavy supply of U.S. Treasurys could bump up bond yields and place greater pressure on stock prices.
Stock markets globally came under heavy selling earlier this month after signs of higher inflation gave rise to fears that the Federal Reserve could hike interest rates at a quicker pace.
Investors are getting used to that now, said PIMCO, but the stock market could be rattled again if there isn't enough demand for the large supply of Treasurys.
"I think the market's starting to come to terms with these higher rates," Mihir Worah, PIMCO's chief investment officer for asset allocation and real return, told CNBC Wednesday.
"It's not just the Fed and inflation coming higher that the market has to get used to, but also Treasury supply. Given the big deficits and tax cuts, there's going to be tremendous Treasury supply in the United States."
The U.S. Department of Treasury is expected to sell $258 billion worth of debt this week. Among the issuance so far is the auction of $28 billion in 2-year notes at a high yield of 2.255 percent — the highest since August 2008.
That, coupled with the release of stronger-than-expected inflation data, saw the 2-year Treasury yield hit its highest level in nearly 10 years.
Higher bond yields when interest rates and inflation are rising may prompt investors to shift funds from stocks to bonds. Such an environment threatens the stock market because stronger inflation eats away at corporate profit margins, and higher interest rates make borrowing costs higher for investors and businesses.
"If yields go up modestly because we're moving from a time where we worry about deflation to a time where we expect modest 2 to 2.5 percent inflation, that's fine," Worah said.
But yields could also creep up when inflation rises faster than expected, or when "there's too much supply of Treasury, too little demand" — scenarios that the stock market should worry about, he added.
That said, the current situation hasn't reached the point where investors should offload all their holdings in stocks, according to Worah. But it's also not the time to invest blindly in the market, he said.
"In the market, there are always things that we like and things that we don't like," he said. "There's always room to find sectors, countries, indices that do well."
— CNBC's Patti Domm contributed to this report.