Friday’s Strong Employment Data Triggers Market Decline
The United States experienced an unexpected surge in employment figures on Friday, with the economy adding 256,000 jobs in December, surpassing consensus estimates by 90,000. Additionally, the unemployment rate dropped unexpectedly to 4.1%.
As a consequence of these robust figures, 10-year Treasury yields increased by 8 basis points to 4.75%, marking their highest point in over a year, while major stock indices fell by approximately 2%.
10-Year Treasury Yields Create Challenges for Equities as They Rise Above 4.4%
Since mid-September, 10-year Treasury yields have been steadily climbing, increasing by 115 basis points within that period. This rise is attributed to several factors:
- Real rates have been ascending, reflecting the resilience of the U.S. economy in maintaining strength despite persistently high interest rates.
- Inflation expectations have also been on the rise as inflation remains above the Federal Reserve’s 2% target.
- Anticipations of potential policy changes have contributed to maintaining these trends.
The chart below illustrates that stock prices have risen alongside Treasury yields up to a certain point since September. However, once 10-year yields surpassed 4.4% in mid-December, further increases in Treasury yields have coincided with declines in stock prices. This pattern has been observable over the past year, with equity prices rising along with bond yields when Treasury yields remain below 4.4%.
Impact of Higher Rates on Equity Valuations
The 4.4% threshold does not hold any intrinsic significance but has been the level where market concerns about equity valuations have emerged over the last year. Investors consider future earnings streams when valuing companies, making interest rates an important factor. Rising rates increase borrowing costs, making it more challenging to justify high price-to-earnings (PE) ratios, which are currently elevated for large-cap stocks. Consequently, a market sell-off can help bring down PE ratios to more sustainable levels.
The future direction of interest rates poses a key question for equity markets. Some analysts predict that 10-year rates could rise to 5% or even higher, potentially hindering further equity gains. Conversely, disappointing economic data or lower inflation figures could lead to a decrease in yields. Upcoming Consumer Price Index (CPI) data will be watched closely for further insights.
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