Investors are more optimistic about rising yields this year because the Fed plans to decrease rates in 2024. Strong economic data has made investors worry the central bank can lower rates as much as planned.
On Tuesday, futures markets priced in 70 basis points in cuts this year, down from 150 bps in January. That falls short of the central bank's 75 bps forecast for this year.
Various measures show stock market values have become less favorable. Keith Lerner, co-chief investment officer at Truist Advisory Services, said the equity risk premium, which compares the S&P 500 earnings yield to the 10-year Treasury yield, turned negative in the first quarter for the first time since 2002.
"Bonds offer some real competition," said Ned Davis Research chief U.S. market strategist Ed Clissold. "So if we were to see the 10-year Treasury yield spike back towards 5% like it did last fall, stocks would probably reflect that and equity valuations would need to come down."
Investors think a pullback is due. Bank of America Global Research data showed that the S&P 500 has not fallen significantly since October, although it typically falls 5% or more three times a year.
"We have been looking for a 3-5% correction for months," said Murphy & Sylvest Wealth Management senior wealth advisor and market strategist Paul Nolte. "We may finally be at the doorstep." Whether investors feel the economy is healthy and inflation is cooling may affect stocks' response to rising yields.
"Because growth has been a lot stronger than expected, then investors will be OK with that," said Federated Hermes multi-asset solutions head Damian McIntyre. "But if growth starts to slow and inflation is climbing then that will start to weigh on investors' minds."
A stronger-than-expected U.S. jobs report on Friday may explain yields' rise. After earnings season begins this month, LSEG IBES expects the S&P 500 to grow 10% this year. "Stocks can weather a lot if earnings are there," said Horizon Investment Services' Carlson. "But if earnings don't continue to beat expectations and you've got rates now going to four-month highs, that is going to be a problem for the market."
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